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lan he mao eases ee ‘he ead elect renmaectng oe Chapter 6 s discussed in Chapter 1, management accountings proces: Involving ideaication, measurement, and accumslation of financial {aformatio. Cost allocation plys an importat ole in these thee apes Dilerert terms maybe used in deserbng the roses f cost allcstion, fr xample allocate, apply, absorb, asin, apportion, reallocate, nd nsf In Chapter 5; the method of allocating manufacturing overheads was induced. Manufacturing overheads (arable and fixed) were Identified though the measure of budgeted ot fctimated overhead cout and were accumulated into the products through the ‘plication of pe-delemined overeal rales, which were determined by the use of respective denominator atvtebsse, being ideally the soderlying divers ofthe respective overhead cots, The azurcy ofthe overead applications was then jst through the overapplie or underapplied overheads using one ofthe following two methods 1. The direst cast of good sold ajstment metho, 2. The proporonal method to adjust cost of gods sold and ending work in process investor ar well as ished goods neat, Wii the previous chapter focuses on the aplication of manfsctaring overheads, this chapter locates en te allocation of nonmansfactaring evetheads (or service ‘department expenses) and posible apportion techniques to ssign these nogprosctcn ts o production andor operating departents Eventual. these costs ae captred inthe final products to reveal the fll cost of the products. In addon fo the objective of identifying the economic values (he fil cst) of the products, which ean be used for income statements and act valuations purposes, thee ave ther qualy important objectives for the aceds for allocating tverbead cost. These objectives canbe derived from the rot purposes of management accounting: plan, ‘evaluate and conte ‘Managers of oreanization require fll Sansa and operstional information to help them make beter decision, including assessment of risk and peat con sequences, when they pln, Fnac including all costs) and operations forecast and ‘budgets, therefore, are essential especially for swage decisions. For example if ‘university spanning for anew postgraduate program, then it choice of cot allostion| ‘method onthe ate of common resources such as socurity guards brary facies, einar rooms, and university TT network tay have significant impact onthe fee. Sing proces swell she ulimate nancial sucess a longterm satiny of the program, "The choice of cost allocation method not ony affects the financial sucess of the productfervices but zo plays an important role in imlting management and ‘worker motivation, Pet youre heir shoes. How will you fel if ots lected to your depatmentprduct ar not elated to your eparmeadpoduct nd not contliable ‘by you but your performance i evaluat based on the Rinncil sows of the eparmendprodust? For example, f the cost of university president and central ‘ministration allocated oa parclar program with significant percentage, the fropatn decor ay feel upect these cose ae no controllable by hele The key, fn fat, is not whether itis conolabl, bt ies inthe evaluation. The program director will ot be weet hsher performance evaluation doesnot isla hs uncon {actor (fom the program's viewpoin) The allocation of uncontoiabl costs om the ter hand, has served te important comununieaton purpose to norm ers tha, 0 the long un, there ae invest cost that need to be recovered trough product ad service pricing i costs allocated are controllable and evaluated then these costs, with stale con nd incentives, may belp achieve more efcleat and effective we of revoures tor evea reduction of costs "You get what you measure"—although this may not be fone hundred percent the tut, It may have significant lnience on the dirttion of te operational deals. Appropriate allocation, therefore may provide sgn to all Darts to ensue long-term sustainability and competitiveness, For example, the rogram director ofthe new posigradite program wil pay more ateation tthe we ‘tthe ai-conioning syst if the inrementl cot of tring te sytem e charged The cost-benefit evalaion plays an important coe providing checks and balances 1 ensure ht allocation are otifiabl and cost eflentlycondorted. Dsngecmeat, intra ghng and low morale are pr ftheintangble cat rd need to be monitored ss many otganzations evaluate cost Senet pursyon tangle measures Silay. tan ‘ble Denes should, eal lobe capture in the nays if the associated cost ben ‘it achivement at Jule Tn adaiton othe above cansdertin, he following fctors ae equally importat in deermiing the cost allocation approach foralloesing service department carp within the same ety or tasfening prices among diferent ens within goo 1. Cause and eect, Te would be reasonable wo expat the deparment that incurs the expenses to absorb 2, Bench received Te would be aguahly fro allocate cots based on he produc or depart that receives the ullmate beset instead of the product or deprtment cating the 3. Ability to bear ‘To ahighly profitable orasizaton, i would be desiabl wo allocate higher cost tothe more profitable dpartmentubsdiary, regres of wheter o ot hee i ny relationship or usage. This it the least desirable from the motivational fetspecve but could belp seduce overall grouplcompany taxation export, fence may be good fom the financial perspective ofthe whole groapleompany Furthermore proponents of th "ability to best” method argue tat alocting ‘more costs to higher loss subsidiaries or products will ot belp recover the allocated costs and wil not bene the groupleompany as a whole. In some fases, customers consuming highly profile products and services ae less destin othe pi ches ad peu hae providing» od oportiy 4. Paine or equity (especialy in government contract) ‘Costs contracts (Cotas xed fe cr award fx) ar popular mong goverment: related comracs especial in the Unit Sines. Cops fio fee meas at & [redetermined fei et 0 top ofthe costs whereas cops svar fei cot ‘los payment based on performance mecs Cospus contracts se bed when ‘bere are difcliesdstermining the costa ie begining othe contac, yt he ‘quality of th outpa isesenial for example, nsec and development pe of ojet inthe mtr and defense indostry and space progas, Therefore, os ‘lus contract is awarded to avoid the cui of cores. To ensure fale, cost Soca for «goverment conact shoul similar to ht fr 8 nongonermest Service Department Charges | Mos large organizations hve both opereting departments an sevice deparment The ‘ctrl purposes of the organization ae cared out nthe operating departments, In ‘omits service departments do ot dec engage in opereng sti Isend,they [Provide services or usistance to the operating departments. Examples of sevice ‘parents include Cafeteria, eral Abdting, Human Resouces, Cost Accoorting, snd Purchasing. locate costs ol sie Sparen oe ener ‘Separating fost banaer ence. Chaptor 6 Service department cots ae charged to operating departments fr variety of| reason inline 1. To encourage operating departments to make wise ue of sevice department rescues. Ifthe services were provided for fee, operting manager would be Fncineto waste thee resource. 2. Toprovid opening departments wth more complet ost at for making dsision, Actions ake by operating departments have impact on sevice department cot. Tor example, hiring anober employee wl increste cot inthe human resoues [g7en000) 000.1. 450,000 rent FORE Teenage upsets cost [Notice that variable seviing cos are charged othe eperatng visions based onthe ‘udgeted ete (S10 per hou) and the actual avy forthe Year In conte, the charges for fixed costs ar hao etrely on budgeted data. Also noe that the wo operating divisions are not charged forthe acta costs of te rervice department, which ae Jnflenced by how well the service deparment i managed. Inea, the service Aeparent ial esponsibl forthe actal cots ot charge tot dept ‘shown onthe nex! page Cost cation 2a “tal actual costs nourod “eal charges (above) Spending vrianoe—resanstity ‘ole Hantenanse Oopertnant ‘AUSTRALIAN RAIL TRACK CORPORATION S inocaeaaur fap comars, be usaien angen sc Come Carmisen ‘aged PreavoltiosaConpets (Pa ree wher ust al re Corporation IAT) soos extent cost lost ofan 2017 when sompsd mts sk 2002 Deol thei as to oteertae tetera ori ees hve ets ‘ace hector a ees a xa re aly cmt ect Pu Gop tat Ns ct oesten mtd as vo resoate ans vas more cele Ahn at fer a oe str. hich Fy gta fave spe opttots Coste oh ARTO were 3 erated) ec ane ret e3ts eried et costs ave the er peo Tater (MPMI sne 946 MEM atch were bared drt oe et eae Ver ‘He eres inet cass wee clorsad y= eoep press woh and Io Scale “ss apne Connon costs wee Neal slerated ena eaual ass vena cone fracas sch sto Moet, ack Klnets, van nowors ogres on oer. Sagres Craton a Consens a NOE Sais Melis fs anon Hn iho Aa ‘Some Cautions in Allocating Service Department Costs. | Pirfalls in Allocating Fixed Costs 262 Chapter 6 —____Beparments Tite Shoes ACceSsones «Tota ‘Sale by depart $250,000 40000 $100,000 $400,000, Porentae of tal sales eon doe as Om ‘ocaton ot arcs department cats, based on pocerage ot toa sles $20.000 $4000 $15,000 $0,000 In the folowing pid, let ut asume the manager of the Suits Department need & ‘coef program 1 expand sae in his deparanent by $100,000. Furteomre et us ‘ssumo tat sles inthe other two departments remained unchanged, tll sevice eparuneat costs remained unchanged, andthe sles departnens expected usage of Service department resources remained unchanged. Given these assumptions, the sevice ‘partment cos alloestions to the sles deparments woud changes shown below —___Bevanments ae ‘Sls Shoes Asoesoree Tota Sales bydopartrent......... $960.090 $40,000 $100.00 $500,009, Percentage ofl sles Te Ok mH, ‘locator of ones cepa ‘oss based on porentage total saes S200 $4800 $12.00 $60,000 Incase (dares) ro ‘ror alocatt ‘34200 $11,200) 51300) % ‘Alles seeing thse allocations, the manager ofthe Suits Deparnenti ikl o complin ‘Secause by rowing Sales ls depart, hes being forced ocr) rer share of ‘heservce department cos In essence this managers bing pulsed foris outs ng ecfcmance by being sded with a rater proportion of sevice deparment costs (On he other hand, te managers ofthe departs tht showed no sales growth re be- Ing relieved ofa potion ofthe cos he had been crying Ye, there ws nochange 0 ‘heamount of services provided for any department ass the two periods, “Thr exsple shows why avaiable location be such as tals dallas shoul only ‘eused sa base for alocating or charging costs those eases wher service depart costs actualy vary withthe chose allocation base. When service department costs ae ‘xed, hey should be charged to operating depareats according to he guidelines me ‘ond earlier. “Th seperation of variable and Sze charges discand (ao known the dal ate ‘method can prevent te treatnt of xed conte 8 vale common prble con ‘location. They can be suramaied as alos: Variable cont charger: Actual atv level X Bagot uni variable ott Fixed coetchages: Allain so X Budgeed fod cost Toa) | Service Department Allocations “The dul rte method mentioned above canbe sen as acing oss sed onthe cat ané-eflect relationship, that, relatively clea relationship between the cost and the Setermining Tacor (or cost driver. Unfortunately, most departments within 30 ‘rpanication tlie resource in more wble force with casa elatonships between the service providers and uers/peoducs, For example, the cot of ruins the cafeteria ‘may nt be filly determined by the number af employees as some employees may thoose o dine ouside or brig ther cwnIuach snd some may consume more oleh than others butte number of employes may be the mot cost-effective way to aocte the expenses, This is an example of perceived benefit received through causel ‘elon. ‘Many Service depariments provide services o eachother, 4 well aso operating departments. Fr example the Cafeteria Deparment provide eas forall employees, ineing those assigned to other service depart, as wala to employers of he operating departments. In tars the Cafeteria Department may receive services from ‘ter serie deparments, such as fom Custodial Serves or fom Personae. Services ‘rovided becween service departments ate known a inendeprtmentl ot reciprocal Serves. Tre approaches ar seo allocate the coats of vice depen to the department: the direct method the sip-down metho, and the reciprocal metho, ‘These thre metho ne discs inthe following sections, Direct Method ‘The direct mettod Is he simples ofthe thee cot locaton methods. It ignores the secvces provided by service deparupent lo ober sevice departnent (eg. epoca Services) and allocates all service department cots recy to operating Soprtnens Even fa service departnent uch as Personnel provide lage amount of ervice to smother sevice deparnent suchas the Cafeteria) a allectons are made etncen the two departments. Rather, al cos are allocated dct othe operating Spares, bypassing the oher sevice department Hence the tem diet method. Fora example of the direct method, consider Mountain iow Hosp, which as ‘wo sevice departnens and two operating depsrtets as shown blow. The hora allocates its Hospital Adnsraton costs onthe basso employe-hors a is Cato- ial Services cos onthe tas of sgt ft osupied sevice perting Deparment Depormorts Hosetsl Custos Pato ‘emmisvaton “Senices Labortay Cue Total ‘Hosa Custoal Services in general incode the following dues: ceasing, di posal of fuse, housekeeping, earying out of ise! and rodent conte and extern Yin procedure, and moving of funiture, supplies, and equipment la conection with leaning asinments ot arscitd with patient car, “The det mend of allocating the hospitals eve department cost tothe ope Ing department is shown in Exit 6-1. Several things shouldbe noed in seb Fit, the employee-hours of the Hospital Admaistten Department andthe Csi Services Departent se ignored when alos the cost of Hospital Adinisaon ‘ing he dst method. Under the dive! method. any of the aloaton be atrbwable {othe tence departments hemsees ignored ony he cmon of te elocation base ‘butable othe operating deparment i sed In the allocation. Note tha the sme rule is used when allocating the cots ofthe Casta Serves Department Even though 282 LenRnine OBECTVE 3 ‘eae sevice cout cts fo epeatng depres “seg cect meted. 264 chapter EXHIBIT 64 Det eed Alcan Dessrimerts Hesptal cused Adminsaior Savloss Laboaton "Care Total ‘Departmeril cai betes aecaton 000000 $90,009 $261,000 sea,000 $1,400,000, location Hospital Adinistaton cots (Ma (960,000) Cistoal Servoas cots ea Tacos ater acest ‘Based onto enployee-nours in th wo operating departments, whch re 1,000 hore + 30.000 hour ~ 48,000 nous, {Bese one eine ot ecules yo Wo epratg depres, Wic8 500 saa et + 45.00 saa et = 50.000 sua Act seve pret casts wera ares slg Be sepdoo nate an ‘he Hospital Adminstration and Cutoial Services departments ocpy some space hi is ignored when the Custodial Services costs ae slot. Finally note tha afte ll tlceations have Been completed lof the service department cont re conti in the two open departments ‘Although the diet metho is smple iis es acute thn the oer methods be- cause ignores intrdoprtmentl veces, Step-Down Method Unlike the dst method, te sep-down method provides for sllocation ofa service de parent's com to oher service departments, a Well as to operating departs The pow method x sequential The sequence typically begins with he dopant fat provides the retest moun’ of service to oe sevice departens, Afters cons hve been allocate, te process continues, step by sep, ending withthe departeat tht pro ‘ides te least amount of services toate servic departments, This tp proce i itsrate in Exit 2 ‘Graphic usator Sip Dov thes Costs ae aloeted to oter ‘opartents onthe base ‘of enployee-hous oats allocated operating dopa ‘hive bai of quae ~— ost locaton 25 EXHIBIT 6-2 ‘tpn Mb ot Aloeaton Seve operating Seperneris _-_Depares Wospial custo Pater Acmnintation SerdcesLabertoy” "Care Deparment ests belo losabon $5e0000 $0000 $261,000 $ Ee,c00 tocar Heep Ancvaton cost a Mt MG" 660000) 40000 9000 za0e00 * CGistodal Servos costs an" Tat cost ate sont. ian00 “13000 _*17.400 $0 S400 Hoven s1400000 Gaoed en tho enploeo-hours Custos aries ance wo operating partes, which are 8000 hours = 1009 hour » 0,000 hours = 85,00 hou, ‘Asin Exhibt 66-1, is locaion ls based en he square eet occuple by he vo operating departments Eshbit6-8 shows the details ofthe nep-down method, Not the following te ky ont abou tes allocations. st, under Allocation in Exhibit 6-3, you se tv loc Sons, or eps. nthe ft stp, the cots of Hospital Administton ae allocated to an ‘te vie depctent (Custodial Services) a well at th opening depres, In ontras to the ect method the allocation tae for HouptalAaiitation cos now Incldes the employee nor for Custotial Services ae well a or the operating Sepa ‘ments However, the allocation bas stil exelndes the employe-hous for Hopital Ad insti ise. Dn bok he diet and step-down methods, any amu thelocation bas tribtable 1 the sence deparonent whe cat bring allocated is aways sored. Second ooking wgn at EDI 6-3, nae dai he second step de he All Cation beading, the cont of Costa Services i allocated to the two operating “eparients, and none ofthe coe allosted to Hospi Adainisraton even tough Hospital Adminstration capes space inthe bln. Jn the step-down method, oy moun’ ofthe allocation base ati atribuabe toa seice deparment whose ct has ltready een located is ignore. Mera sevice departent scons ave bee alos, nts of oer sevice departments ae not aloes tak to Thi not that he cost ‘of Casta Servics allocated to other departments nthe second step ($130 000) in Estibit6-3 includes the cost of Hospital Admnisaton that were allocated o Cosel Series in he st step Ei 3. DE erect emaneonveeelinerieuee fll Bl ocr eee tn ee eri eee 2 tara ec eee cre Siemens oy cat hrs to pogran = Aoaon arcetgs x Tt uit cot, he satin pete « sar rat Spaa™ barca Couns cos scsi mal iinet tht cle tepcom alsin procedure is sed io aca costs arong fe cotl sec agence (OSA) mln cst Boras amore CSA and ub oe eet agence. The leat respect ton he eanaton str, a ach CSke coe shoud be compte aca ae te ‘Som estan net nse rn cps oy Ct Sec Cone Reciprocal Method The reciprocal method gives full recognition to interdeparmental eevee. Under She step-down method discussed above only paral recognition of interdeprtnental services is possible. The step-down method always allocates costs forward-—neve backward The epoca metod by contrast alloeaes sevice depart css in both retons. Thus, because Custodial Services inthe prior example proves services for spt Administsion, part of Castodial Service’ costs wil be allocated ack 0 Hospital Adminstration Hf the reiproealmetod tweed. At the same time, past of Hospital Adanistation’s costs will be allostted forward to Custodial Services. Reetproca allocation segues the use of eimalaaads liner equation and is beyond thesope ofthis ook, Examples fhe eipocal method can be foundia more sane CONSULTATIVE GROUP ON INTERNATIONAL AGRICULTURAL RESEARCH (CGIAR) INDIRECT COST ALLOCATION GUIDELINES The Cnsitatve Group on tsratonl Agata esearch (CGAR) isa global serersp po tng stan eeparem aputrebugh restora reser anspor he Iosarsincde he governor of dep and nustalaed cous, crane on rm ten andra erga ned tapes ansoareny eth se of eg a fai locaton costs to poets an ung tes, ran engage, hd, 5 200 pode ales gue cost slain ethos a ela open deal ek, bt ne, eatin of aetna, resis ver, and maaaenet tetido bop conten pact on cot slain fr eared ate od be located by Mor sea and vice maktraen stu be aleeaudy te ence wo te ruber f pes slong 0 ewer deparent nt csact mass waste. Th loc ‘on lle was cla Id to erator et cos alco crue rein the Sia ar tepdoan mats. i 2008, th gdenes wee stay used yh odo of eybased costing verge a else oes Sauces Cxutate Geen natn eel seh COND ak Cos Aca Ctl, ‘int 201 a 208 oe