CostAccountingSeventeenthEdition,GlobalEditionChapter16AllocationofSupport-DepartmentCosts,CommonCosts,andRevenuesLearningObjectives(1of2)16.1Distinguishthesingle-ratemethodfromthedual-ratemethod16.2Understandhowthechoicebetweenallocationbasedonbudgetedandactualratesandbetweenbudgetedandactualusagecanaffecttheincentivesofdivisionmanagers16.3Allocatemultiplesupport-departmentcostsusingthedirectmethod,thestep-downmethod,andthereciprocalmethod16.4Allocatecommoncostsusingthestand-alonemethodandtheincrementalmethodLearningObjectives(2of2)16.5Explaintheimportanceofexplicitagreementbetweencontractingpartieswhenthereimbursementamountisbasedoncostsincurred16.6UnderstandhowbundlingofproductscausesrevenueallocationissuesandthemethodsmanagersusetoallocaterevenuesAllocatingSupportDepartmentCostsUsingSingle-RateandDual-RateMethods(1of2)Howacompanyallocatesitsoverheadandinternalsupportcosts—costsrelatedtomarketing,advertising,andotherinternalservices—amongitsvariousproductiondepartmentsorprojectscanhaveabigimpactonhowprofitablethosedepartmentsorprojectsare.Operating(production)department—directlyaddsvaluetoaproductorservice.Support(service)department—providestheservicesthatassistotherinternaldepartments(operatingdepartmentsandothersupportdepartments)inthecompany.AllocatingSupportDepartmentCostsUsingSingle-RateandDual-RateMethods(2of2)Managersfacetwoquestionswhenallocatingthecostsofasupportdepartmenttooperatingdepartmentsordivisions:Shouldfixedcostsofsupportdepartmentsbeallocatedtooperatingdivisions?Iffixedcostsareallocated,shouldvariableandfixedcostsofthesupportdepartmentbeallocatedinthesameway?TwoMethodstoAllocateSupportDepartmentCosts:Single-RateandDual-Rate(1of2)Dependingontheanswertoourfirstquestion(fromthepriorslide),therearetwoapproachestoallocatingsupport-departmentcosts:thesinge-ratecostallocationmethodandthedual-ratecost-allocationmethod.Thesingle-ratemethoddoesnotdistinguishbetweenfixedandvariablecosts.Itallocatescostsineachcostpoolusingthesamerateperunitofasingleallocationbase.Asupportdepartmentwouldbeanexampleofacost-pool.TwoMethodstoAllocateSupportDepartmentCosts:Single-RateandDual-Rate(2of2)Thedual-ratemethodpartitionsthecostofeachsupportdepartmentintotwopools,avariable-costpoolandafixed-costpool.Itallocateseachpoolusingadifferentcost-allocationbase.AllocationBasesUndereithermethod,allocationofsupportcostscanbebasedononeofthethreefollowingscenarios:BudgetedoverheadrateandbudgetedhoursBudgetedoverheadrateandactualhoursActualoverheadrateandactualhoursWhenusingeithermethod,managerscanallocatesupport-departmentcoststooperatingdivisionsbasedoneitherabudgetedrateortheeventualactualcostrate.Wecanalsoallocatebasedondemand(usage)orsupply(practicalcapacity).Thelatterapproach(usingactualrates)isneitherpreferrednorwidelyused;wewillillustrateusingbudgetedrates.AdvantagesandDisadvantages:Single-RateMethodAdvantagesLesscostlytoimplementOffersuserdepartmentssomeoperationalcontroloverthechargestheybearDisadvantagesMayleadoperatingdepartmentmanagerstomakesuboptimaldecisionsthatareintheirownbestinterestbutmaybeinefficientfromthestandpointoftheorganizationasawholeAdvantagesandDisadvantages:Dual-RateMethod(1of2)AdvantagesGuidesdepartmentmanagerstomakedecisionsthatbenefitboththeorganizationasawholeandeachdepartmentAllocatingfixedcostsbasedonbudgetedusagehelpsuserdepartmentswithbothshort-runandlong-runplanningbecauseuserdepartmentsknowthecostsallocatedtotheminadvanceAdvantagesandDisadvantages:Dual-RateMethod(2of2)DisadvantagesRequiresmanagerstodistinguishvariablecostsfromfixedcosts,whichisoftenachallengingtaskDoesnotindicatetooperatingmanagersthecostoffixedsupportdepartmentresourcesusedbecausefixedcostsareallocatedtooperatingdepartmentsbasedonbudgetedratherthanactualusageAllocatingfixedcostsonthebasisofbudgetedlong-runusagemaytemptsomemanagerstounderestimatetheirplannedusage.BudgetedVersusActualCostsandtheChoiceofAllocationBase(1of4)Theallocationmethodspreviouslyoutlinedfollowspecificproceduresintermsofthesupportdepartmentcoststhatareconsideredaswellasthemannerinwhichcostsareassignedtotheoperatingdepartments.Wewillnowexaminethesechoicesingreaterdetailandconsidertheimpactofalternativeapproaches.We’llseehowthosedecisionshaveasignificantimpactonthecostallocatedtoeachoperatingdepartmentandtheincentivesoftheoperatingdepartmentmanagers.BudgetedVersusActualCostsandtheChoiceofAllocationBase(2of4)Budgetedversusactualrates—Useofactualratesimposesahighlevelofuncertaintyonuserdepartments.Budgetedratestendtomotivatethemanagerofthesupport(orsupplier)departmenttoimproveefficiencyandtodecideappropriately(ifallowed)whethertousetheinternalresourceoranexternalvendor.Budgetedversusactualusage—Actualusageisbestherebecausethevariablecostsaredirectlyandcausallylinkedtousage.Also,allocatingvariablecostsonthebasisofbudgetedusagewouldprovidetheuserdepartmentswithnoincentivetocontroltheirconsumptionofsupportservices.BudgetedVersusActualCostsandtheChoiceofAllocationBase(3of4)Fixed-costallocationbasedonbudgetedratesandbudgetedusage—Whenbudgetedusageistheallocationbase,userdepartmentsreceiveapresentlump-sumfixed-costcharge.Ratescanbesetbasedonbudgetedusageoronpracticalcapacity.Fixed-costallocationbasedonbudgetedratesandactualusage—Ifactualusageisequaltobudgetedusagebutlessthanpracticalcapacity,100%ofthedepartmentscostsareallocatedeventhoughthedepartmenthadidlecapacity.BudgetedVersusActualCostsandtheChoiceofAllocationBase(4of4)Allocatingbudgetedfixedcostsbasedonactualusage—Whenbudgetedfixedcostsareallocatedbasedonactualusage,userdepartmentswillnotknowtheirfixed-costallocationsuntiltheendofthebudgetperiod.Therefore,thismethodsharestheflawasthemethodsthatrelyontheuseofactualcostsratesratherthanbudgetedcostrates.Insummary,strongeconomicandmotivationalreasonsjustifythepreciseformsofthesingle-rateanddual-ratemethodsconsideredintheprevioussectionand,inparticular,tosupporttheuseofthedual-rateallocationprocedure.AllocatingCostsofMultipleSupportDepartments(1of2)Now,weexaminethespecialcost-allocationproblemsthatarisewhentwoormoreofthesupportdepartmentswhosecostsarebeingallocatedprovidereciprocalsupporttoeachotheraswellastooperatingdepartments.Theallocationisdoneinthreesteps:Traceorallocateeachcosttovarioussupportandoperatingdepartments.Allocateplantadministrationcoststoothersupportdepartmentsandoperatingdepartments.Allocatethesupportdepartmentcoststotheoperatingdepartments.AllocatingCostsofMultipleSupportDepartments(2of2)Threemethodscanbeusedfortheallocations:DirectMethod—allocateseachsupportdepartment’sbudgetedcoststooperatingdepartmentsonly;noallocationstoothersupportdepartmentsStep-DownMethod—allocatessupport-departmentcoststoothersupportdepartmentsandtooperatingdepartmentsinasequentialmannerthatpartiallyrecognizesthemutualservicesprovidedamongallsupportdepartmentsReciprocalMethod—allocatessupport-departmentcoststooperatingdepartmentsbyfullyrecognizingthemutualservicesprovidedamongallsupportdepartmentsDirectMethodAllocatessupportcostsonlytooperatingdepartmentsDirectmethoddoesnotallocatesupport-departmentcoststoothersupportdepartments.DataUsedinCostAllocationExampleExhibit16.3DataforAllocatingSupportDepartmentCostsatRobinsonCompanyDirectAllocationMethodIllustratedExhibit16.4DirectMethodofAllocatingSupportDepartmentCostsatRobinsonCompanyDirectAllocationMethodExampleExhibit16.4DirectMethodofAllocatingSupportDepartmentCostsatRobinsonCompanyStep-DownMethodAlsocalledthesequentialallocationmethod.Allocatessupport-departmentcoststoothersupportdepartmentsandtooperatingdepartmentsinasequentialmannerthatpartiallyrecognizesthemutualservicesprovidedamongallsupportdepartments.Step-DownAllocationMethodIllustratedExhibit16.5Step-DownMethodofAllocatingSupportDepartmentCostsatRobinsonCompanyStep-DownAllocationMethodExampleExhibit16.5Step-DownMethodofAllocatingSupportDepartmentCostsatRobinsonCompanyReciprocalMethodAllocatessupport-departmentcoststooperatingdepartmentsbyfullyrecognizingthemutualservicesprovidedamongallsupportdepartments.Reciprocalmethodfullyincorporatesinterdepartmentalrelationshipsintothesupport-departmentcostallocation.Itisalsoknownasthematrixmethod.Analternativewaytoimplementthereciprocalmethodistoformulateandsolvelinearequations.Thisimplementationrequiresthreesteps.ReciprocalAllocationMethod(RepeatedIterations)ExampleExhibit16.6ReciprocalMethodofAllocatingSupport-DepartmentCostsUsingRepeatedIterationsatRobinsonCompanyReciprocalAllocationMethod(LinearEquations)Thereciprocalmethodcanalsobeimplementedbyformulatingandsolvinglinearequations.Thisprocessrequiresthreesteps:Expresssupportdepartmentbudgetedcostsandreciprocalrelationshipsintheformoflinearequations.Solvethesetoflinearequationstoobtainthecompletereciprocatedbudgetedcostsofeachsupportdepartment.Allocatethecompletereciprocatedcostsofeachsupportdepartmenttoallotherdepartmentsonthebasisofthebudgetedusagepercentages.ReciprocalAllocationMethod(LinearEquations)IllustratedExhibit16.7ReciprocalMethodofAllocatingSupport-DepartmentCostsUsingLinearEquationsatRobinsonCompanyReciprocalAllocationMethod(LinearEquations)ExampleExhibit16.7ReciprocalMethodofAllocatingSupport-DepartmentCostsUsingLinearEquationsatRobinsonCompanyOverviewofMethodsDifferencesamongthethreemethods’allocationsincreaseasthemagnitudeofthereciprocalallocationsincreasesandasthedifferencesacrossoperatingdepartments’usageofeachsupportdepartment’sservicesincrease.Reciprocalisconceptuallythemostprecisebecauseitconsidersthemutualservicesprovidedamongallsupportdepartments.Directandstep-downaresimpletocomputeandunderstand.Directmethodiswidelyused,butascomputingpowertoperformrepeatediterationsincreases,morecompaniesfindthereciprocalmethodeasiertoimplement.AllocatingCommonCostsCommoncost—thecostofoperatingafacility,activity,orcostobjectwhenthatfacility,activity,orcostobjectissharedbytwoormoreusersCommoncostsarisebecauseeachuserincursalowercostbysharingafacilityoractivitythanoperatingthefacilityorperformingtheactivityindependently.Thecostaccountingchallengeishowtoallocatecommoncoststoeachuserinareasonableway.Weusetwodifferentmethodstoallocatecommoncosts.MethodsofAllocatingCommonCosts:Stand-AloneMethodStand-alonecost-allocationmethoddeterminestheweightsforcostallocationbyconsideringeachuserofthecommoncostfacilityoractivityasaseparateentity.Individualcostsareaddedtogether,andallocationpercentagesarecalculatedfromthewholeandappliedtothecommoncost.MethodsofAllocatingCommonCosts:IncrementalCost-AllocationMethodIncrementalcost-allocationmethodrankstheindividualusersofacostobjectintheorderofusersmostresponsibleforthecommoncostandthenusesthisrankingtoallocatethecostamongtheusers.Thefirst-rankeduseristheprimaryuserandisallocatedcostsuptothecostsasastand-aloneuser(typicallygetsthehighestallocationofthecommoncosts).Thesecond-rankeduseristhefirstincrementaluserandisallocatedtheadditionalcostthatarisesfromtwousersratherthanone.Subsequentusersarehandledinthesamemannerasthesecond-rankeduser.CostAllocationsandContractDisputes(1of2)TheU.S.governmentreimbursesmostcontractorsinoneoftwomainways:Thecontractorispaidasetpricewithoutanalysisofactualcontractcostdata.Thecontractorispaidafterananalysisofactualcontractcostdata.Insomecases,thecontractwillstatethatthereimbursementamountisbasedonactualallowablecostsplusafixedfee(cost-pluscontract).AllcontractswithU.S.governmentagenciesmustcomplywithcostaccountingstandardsissuedbytheCostAccountingStandardsBoard(CASB).CostAllocationsandContractDisputes(2of2)TheCASBhastheexclusiveauthoritytomake,putintoeffect,amend,andrescindcostaccountingstandardsandinterpretations.Thestandardsaredesignedtoachieveuniformityandconsistencyinthemeasurement,assignment,andallocationofcoststogovernmentcontractswithintheUnitedStates.Thestandardsrepresentthecomplexinterplayofpoliticalconsiderationsandaccountingprinciples.Termssuchasfairnessandequity,aswellascauseandeffectandbenefitsreceived,arerelevanttoandapartofgovernmentcontracts.BundledProductsandRevenueAllocationMethods(1of2)Revenuesareinflowsofassetscompaniesreceiveforproductsorservicesprovidedtocustomers.RevenueallocationoccurswhenrevenuesarerelatedtoaparticularREVENUEOBJECTbutcannotbetracedtoitinaneconomicallyfeasible(cost-effective)way.Revenueobject—anythingforwhichaseparatemeasurementofrevenueisdesiredBundledProductsandRevenueAllocationMethods(2of2)Bundledproduct—apackageoftwoormoreproductsorservicesthatissoldforasingleprice,butwhoseindividualcomponentsmaybesoldasseparateitemsattheirown“stand-alone”price