COLLABORATE TUTORIAL 2,
AYN 414: COST AND MANAGEMENT ACCOUNTING
After completing the following questions, you should be able to:
• Allocate overheads amongst support and operating departments using the
direct method, the step-down method, and the reciprocal method.
• Understand the situations where each method is likely to be applicable.
• Understand how usage of the dual rate can limit the risk of one
department being charged for any one period most of the support department
costs.
• Understand the issues in allocating fixed costs.
Question 1: Support department cost allocation; direct and step-down methods.
Olympiakos, SA, provides outsourcing services and advice to both government and
corporate clients. For costing purposes, Olympiakos classifies its departments into two
support departments (Administrative/Human Resources and Information Systems) and
two operating departments (Government Consulting and Corporate Consulting). For the
first quarter of 2014, Olympiakos incurs the following costs in its four departments:
Administrative/Human Resources (A/HR) € 600,000
Information Systems (IS) € 2,400,000
Government Consulting (GOVT) € 8,756,000
Corporate Consulting (CORP) € 12,452,000
The actual level of support relationships among the four departments for the first quarter
of 2014 was:
Used by
A/HR IS GOVT CORP
Supplied A/HR 25% 40% 35%
By IS 10% 30% 60%
The Administrative/Human Resource support percentages are based on headcount. The
Information Systems support percentages are based on actual hours of computer time
used.
REQUIRED:
1. Allocate the two support department costs to the two operating departments
using the following methods:
a. Direct method.
b. Step-down method (allocate Administrative/Human Resources first).
c. Step-down method (allocate Information Systems first).
2. Compare and explain differences in the support department costs allocated to
each operating department.
3. What criteria could determine the sequence for allocating support departments
using the step-down method? What criterion should Olympiakos use if government
consulting jobs require the step-down method?
Bhimani, A.., Horngren, C. T., Datar, S. M., and Rajan. M.V. 2012. Management and Cost
Accounting, Prentice Hall, p. 162.
Question 2: Support department cost allocation; direct and reciprocal method.
Greenfield Garden Company manufactures gauges for watering systems used in
greenhouses. The company has two production departments: Machinery and Finishing.
There are also two support departments: Human Resource (HR), and Maintenance (M).
The budgeted overhead costs for 2014 for each department are as follows.
HR 350 000
Maintenance 275 000
Machinery 650 000
Finishing 340 000
The usage of the support departments’ output for the year is as follows:
User of the Service HR Maintenance
HR - 15%
Maintenance 10% -
Machinery 60% 50%
Finishing 30% 35%
Required:
a. Use the direct method to allocate the budgeted costs of the Human Resources
and Maintenance to the Machinery and Finishing departments.
AND
b. Use the reciprocal method to allocate the budgeted costs of the Human
Resources and Maintenance departments to the Machinery and Finishing
Departments.
Question 3: Departmental cost allocation, university computer centre.
A computer-service centre of Madrid University serves two major users, the department of
Engineering and the department of Humanities of Sciences (H&S).
REQUIRED:
a. When the computer equipment was initially installed, the procedure for cost
allocation was straightforward. The actual monthly costs were compiled and divided
between the two departments on the basis of the computer time used by each. In
October, the costs were €100 000. H&S used 100 hours and Engineering used 100
hours. How much cost should be allocated to each department? Suppose costs were
€110 000 because of various inefficiencies in the operation of the computer centre.
How much cost would then be allocated? Does such an allocation seem justified? If
not, what improvement would you suggest?
b. Use the same approach as in requirement 1. The actual cost-behaviour pattern
of the computer centre was €80 000 fixed cost per month plus €100 variable cost per
hour used. In November, H&S used 50 hours and Engineering used 100 hours. How
much cost would be allocated to each department? Use a single-rate method.
c. As the computer-service centre developed, a committee was formed that
included representatives of H&S and Engineering. This committee determined the size
and composition of the centre’s equipment. The committee based its planning on the
long-run average utilization of 180 monthly hours for H&S and 120 monthly hours for
Engineering. Suppose the €80 000 fixed costs are allocated through a budgeted
monthly lump sum based on long-run average utilization. Variable costs are allocated
through a budgeted unit rate of €100 per hour. How much cost should be allocated to
each department? What are the advantages of this dual rate allocation method over
other methods?
d. What are the likely behavioural effects of lump-sum allocations of fixed costs?
For example, if you were the representative of H&S on the facility planning committee,
what would your biases be in predicting long-run usage? How would top management
counteract the bias?
Bhimani, A.., Horngren, C. T., Datar, S. M., and Rajan. M.V. 2012. Management and Cost
Accounting, Prentice Hall, p. 163.
