Cost Allocation
Practice As You Learn
Cost Accounting
1) Memorize the definitions of all terms stated in key things to know
2) Know how to allocate support costs to revenue generating areas of a company using
a) the direct method – costs are allocated only to revenue producing units
b) the step method – costs are allocated to cost and revenue producing units
Direct method procedure:
1) Determine an activity base for the cost unit
2) Total the base and get the % of the base that is provided to each revenue producing unit. Ignore activity that occurs at other service units.
Multiply the % for each revenue producing unit x total cost and allocate the amount to each revenue producing unit
Service / Admin unit costs are allocated to revenue producing units ONLY
Step method procedure:
1) Identify the benefits ranking, the order costs will be allocated.
2) Determine an activity base for each cost unit
3) Total the base and get the % of the base that is provided to each other cost unit and revenue producing unit.
Include activity that occurs at all other cost units and revenue producing units that receive the service
4) Allocate in order of the benefits ranking.
Do not allocate any other costs to a cot unit after allocating the costs of a cost unit.
Allocated to other service/administrative units and revenue producing units.
Practice Problem
An accounting firm allocates service department costs to revenue producing departments. The following information is related to each department.
| Direct Costs | # employees | Square Feet |
Reports generated |
|
| Human Resources | $124,000 | 8 | 980 | 325 |
| Computer Services | $267,000 | 9 | 1,270 | 145 |
| Facilities | $850,000 | 6 | 900 |
40 |
| Audit | $534,000 | 15 | 9,875 | 5,400 |
| Tax | $697,000 | 18 | 12,560 | 6,900 |
The human resource costs are allocated based on # employees. Computer services costs are allocated based on reports generated. Facilities costs are allocated based on square footage. Revenues generated by Audit and Tax are $1,900,000 and $1,400,000, respectively. The benefits ranking is human resources, computer services, and then facilities.
A. Using the direct method – allocated service department costs to revenue producing areas. Determine the operating profit for each revenue producing unit.
B. Using the step method – allocate service department costs to revenue producing areas. Determine the operating profit for each revenue producing unit.
Answer
A. Direct Method
1) Compute the % that should be allocated given the base activity for each cost
Use only the activity associated with revenue producing units:
2) Multiply the % of the total for revenue departments by the direct cost of the service department to get the cost allocated to the revenue department
Human Resources: based on # employees
| (1) (2) | |
| Audit | 15 = .455 x 124,000 = 56,420 allocated to audit |
| Tax | 18 = .545 x 124,000 = 67,580 allocated to tax |
| Total | 33 |
Computer Services – based on # reports
|
(1) (2) Audit 5,400 = .439 x 267,000 = 117,213 |
Facility – based on square feet
|
(1) (2) Audit 9,875 = .440 x 850,000 = 374,000 |
Profits using direct method:
| Audit | Tax | |
| Revenues | 1,900,000 | 1,400,000 |
| – Direct Costs | 534,000 | 697,000 |
| – Human Resources | 56,420 | 67,580 |
| – Computer Services | 117,213 | 149,787 |
| – Facilities | 374,000 | 476,000 |
| Operating Income | 818,367 | 9,633 |
B. Step Method:
1) Compute the % that should be allocated given the base activity for each lower ranking cost unit and revenue producing units.
2) Multiply the % of the total x the cost of the department to determine the amount that will be allocated to all lower ranking cost units and revenue units.
3) When determining the total cost for each cost unit to be allocated, add all costs from all departments that have previously been allocated to this cost unit.
Eventually all service and administrative unit costs will be allocated to revenue units.
Do not allocate direct costs of revenue producing units
Allocate the human resources costs to all other cost and revenue producing units:
| # employees | ||
| Computer Services | 9 = | .188 x 124,000 = 23,312 |
| Facilities | 6 = | .125 x 124,000 = 15,500 |
| Audit | 15 = | .312 x 124,000 = 38,688 |
| Tax | 18 = | .375 x 124,000 = 46,500 |
| Total | 48 |
Next, allocate all computer services costs (267,000 + 23,312 = 290,312) to all lower ranking cost and all revenue producing units
| # reports | ||
| Facilities | 40 | = .003 x 290,312 = 871 |
| Audit | 5,400 | = .438 x 290,312 = 127,157 |
| Tax | 6,900 | = .559 x 290,312 = 162,284 |
| Total | 12,340 |
Next, allocate all facilities costs (850,000 + 15,500 + 871 = 866,371) to all revenue producing units. No units rank below facilities.
| Audit | 9,875 = .440 x 866,371 = 381,203 |
| Tax | 12,560 = .560 x 866,371 = 485,168 |
| Total | 22,435 |
Profits using step method:
| Audit | Tax | |
| Revenues | 1,900,000 | 1,400,000 |
| – Direct Costs | 534,000 | 697,000 |
| – Human Resources | 38,688 | 46,500 |
| – Computer Services | 127,157 | 162,284 |
| – Facilities | 381,203 | 485,168 |
| Operating Income | 818,952 | 9,048 |