Blueprint Problem: Support Department Cost Allocation

The Difference Between Support Departments and Producing Departments

When a firm decides that a plant wide overhead rate is not sufficient (perhaps it makes multiple products and the various products go through some processes but not all), it may decide to departmentalise. The factory is divided into departments and costs are accumulated within the departments. When that is done, there are basically two types of departments: producing departments that actually make units of product, and support departments that do not make the product but assist or support the producing departments. Costs of support departments are allocated to producing departments for the following reasons: inventory valuation, product-line profitability, pricing, and planning and control.

From the list below, determine which of the following are producing departments:

Departments		Is it a producing department?
Assembly
Human Resources
Industrial engineering (in a bread factory)
Baking (in a bread factory)
Packaging
Accounting (in a paint factory)
Welding (in a auto manufacture)
Maintenance
Mixing (in a food factory)

Some costs are hard to associate with a single department, so a final catch-all department may be created called General Factory. This department includes all overhead costs that could not be traced to the other departments. For example, the salary of the plant superintendent and the cost of landscaping and grounds keeping may be included in General Factory.

Once the factory is departmentalized, the costs of each department are traced to that department. All costs in the support departments are overhead costs. Costs in the producing departments can include direct overhead. For example, overhead cost directly traced to a producing department may include depreciation on machinery and the salary of the departmental supervisor.

Single and Dual Charging Rates

A support department may develop a charging rate that is used to charge other departments that use the service. This is similar to an overhead rate. For example, Davis Company's information technology (IT) department is in charge of purchasing, installing and assisting other departments with computers and other forms of information technology. The IT department may develop a single charging rate by determining all budgeted costs for the year and dividing by the budgeted hours of IT personnel usage.

Suppose the budgeted costs of the Davis Company IT Department for the coming year equal $240,000 and budgeted hours of service provided equal 5,000.

What is the charging rate for the coming year? $_/service hour.

If the Payroll Department uses 30 hours of IT service next year, how much is that department charged by IT? $_

Notice that the charging rate is computed using budgeted numbers, but that the actual charge is the predetermined rate times actual usage of IT service hours. At the end of the year, the total amount charged out is compared to the total actual cost of the IT department to determine its efficiency/inefficiency.

Dual charging rates require the department to separate fixed from variable costs and develop charging rates for each. In this way, the user departments are charged for their original capacity requirement through the fixed allocation and then charged for their actual usage of variable costs through the variable rate.

Suppose that the Davis Company IT Department serves four other departments: Payroll, Factory, Human Resources, and Engineering. When the IT Department was organized, those using departments said they would need the following hours of IT service in a year:

		Estimated Hours of IT Service			Percentage of IT Service
Payroll		100			2.00%
Factory		2,000			40.00%
Human Resources		1,500			30.00%
Engineering		1,400			28.00%
Total		5,000			100.00%

Davis' IT Department estimated that it would require budgeted fixed cost of $120,000 and variable costs of $20 per service hour. Calculate the fixed cost to be allocated to each of the four using departments and the variable costs to be assigned using the variable rate. What is the total amount charged to each department using these dual rates? (Fill in the following table.)

Estimated Hours of IT Service

Percentage of IT Service

Fixed IT Cost Allocated

Actual Hours of IT Service Used

Variable Cost Allocated Using $20 Rate

Total IT Cost Allocated

Payroll

100

_%

$_

30

$_

$_

Factory

2,000

_%

_

2,200

_

_

Human Resources

1,500

_%

_

1,200

_

_

Engineering

1,400

_%

_

1,400

_

_

Total

5,000

_%

$_

4,830

$_

$_

Why was less charged in total than the budgeted amount of $240,000?

Is it possible to allocate more IT cost to the four user departments than budgeted?

Support Department Cost Allocation Using the Direct Method

Factory accountants usually allocate support department costs to the producing departments using one of three methods: the direct method, the sequential (or step) method, or the algebraic (or reciprocal) method. The objective is simple - to get all factory costs into the producing departments in order to calculate overhead rates and apply them to units produced. Why can't support departments allocate overhead costs to units produced?

The direct method involves allocating overhead cost from the support departments to the producing departments. The direct method never allocates cost from one support department to another support department. As a result, it is the easiest of the three methods.

Let's use Porter Company, as an example. Porter has two producing departments - Fabricating and Assembly - and three support departments - Maintenance, Human Resources (HR) and General Factory (GF). Porter provided the following information on the five departments:

		Maintenance			HR			GF			Fabricating			Assembly
Direct overhead cost		$80,000			$120,000			$260,000			$93,400			$56,700
Machine hours		1,000			3,000			5,000			12,000			3,000
Direct labor hours		4,000			5,000			8,000			10,000			30,000
Square footage		500			2,500			10,000			12,000			18,000

Porter uses the direct method of support department cost allocation. Maintenance is allocated based on machine hours, HR on the basis of direct labor hours, and GF on the basis of square footage. The Fabricating overhead rate is based on machine hours and the Assembly overhead rate is based on direct labor hours.

Fill in the following table to allocate support department costs to the producing departments. (Round all allocation ratios to four significant digits and all allocated amounts to the nearest dollar. If an amount box does not require an entry, leave it blank or enter "0".)

Maintenance

HR

GF

Fabricating

Assembly

Direct overhead cost

$80,000

$120,000

$260,000

$93,400

$56,700

Allocate:

Maintenance

_

_

_

_

_

Human Resources

_

_

_

_

_

General Factory

_

_

_

_

_

Total after allocation

$_

$_

$_

$_

$_

Notice that after allocation, zero dollars remain in the support departments and all overhead cost has been allocated to the producing departments. As a check on your work, add up all direct overhead costs from the first line - it equals $610,100. Then add the totals after allocation - again, it equals $610,100.

Finally, calculate the overhead rates (rounded to the nearest cent) for Fabricating and Assembly.

Fabricating overhead rate $_ per machine hour

Assembly overhead rate $_ per direct labor hour

Suppose that the square footage for Fabricating and Assembly were equal at 12,000 each. How would that affect the allocation of the following:

Maintenance:_

Human Resources:_

General Factory:_

Support Department Cost Allocation Using the Step or Sequential Method

The step or sequential method requires that support departments be ranked and that the highest ranking support department be allocated first to all lower ranking support departments and the producing departments. Then the highest ranking support department is closed and the second-highest ranking support department is allocated to lower ranking support departments and the producing departments. This continues until all support department cost has been allocated to the producing departments. The sequential method takes__ account of support department reciprocity. Reciprocity occurs when one support department uses the services of another support department. For example, Maintenance uses HR and HR may use the services of Maintenance. The sequential method does not take full account of reciprocity because lower ranking support department costs are __allocated to higher ranking support departments.

Let's use Porter Company, as an example. Porter has two producing departments (Fabricating and Assembly) and three support departments (Maintenance, Human Resources (HR) and General Factory (GF)). Porter provided the following information on the five departments:

		Maintenance			HR			GF			Fabricating			Assembly
Direct overhead cost		$80,000			$120,000			$260,000			$93,400			$56,700
Machine hours		1,000			3,000			5,000			12,000			3,000
Direct labor hours		4,000			5,000			8,000			10,000			30,000
Square footage		500			2,500			10,000			12,000			18,000

Porter uses the sequential method of support department cost allocation, and support departments are ranked in order of direct overhead cost (from high to low). Maintenance is allocated based on machine hours, HR on direct labor hours, and GF on the basis of square footage. The Fabricating overhead rate is based on machine hours and the Assembly overhead rate is based on direct labor hours.

Calculate the allocation ratios to five significant digits and fill them into the following table (If an amount box does not require an entry, leave it blank or enter "0".) :

Maintenance

HR

GF

Fabricating

Assembly

General Factory

_

_

_

_

_

Human Resources

_

_

_

_

_

Maintenance

_

_

_

_

_

Using the allocation ratios, fill in the following table to allocate support department costs to the producing departments. (Round all allocated amounts to the nearest dollar. Leave cells blank that do not require an entry.)

Maintenance

HR

GF

Fabricating

Assembly

Direct overhead cost

$80,000

$120,000

$260,000

$93,400

$56,700

Allocate:

Maintenance

_

_

_

_

_

Human Resources

_

_

_

_

_

General Factory

_

_

_

_

_

Total after allocation

Notice that after allocation, zero dollars remain in the support departments and all overhead cost has been allocated to the producing departments. As a check on your work, add all direct overhead costs from the first line - it equals $610,100. Then add the totals after allocation - again, it equals $610,100.

Finally, calculate the overhead rates (rounded to the nearest cent) for Fabricating and Assembly.

Fabricating overhead rate $_ per machine hour

Assembly overhead rate $_ per direct labor hour

Support Department Cost Allocation Using the Algebraic or Reciprocal Method

The algebraic or reciprocal method takes full account of support department reciprocity. This method requires the solution of a system of simultaneous equations to determine the total support department costs to be allocated. In practice, relatively few companies use the reciprocal method.

Let's use Anders Company, as an example. Anders has two producing departments - Cutting and Sewing - and two support departments - Maintenance and General Factory (GF). Anders provided the following information on the four departments:

		Maintenance			GF			Cutting			Sewing
Direct overhead cost		$10,000			$270,000			$56,400			$75,000
Machine hours		459			2,000			9,000			9,000
Square footage		2,500			3,418			5,000			8,500

Anders uses the algebraic method of support department cost allocation. Maintenance is allocated based on machine hours, and GF on the basis of square footage.

Calculate the allocation ratios to five significant digits and fill them into the following table (Leave cells blank that do not require an entry.):

Maintenance

GF

Cutting

Sewing

General Factory

_

_

_

_

Maintenance

_

_

_

_

Using the allocation ratios, solve a system of simultaneous equations for support department cost as follows.

Maintenance = $100,000 + 0.15625 GF

GF = $270,000 + 0.1 Maintenance

Substituting Maintenance into the equation for GF and solving for GF:

GF = $270,000 + 0.1 ($100,000 + 0.15625 GF)

GF = $270,000 + $10,000 + 0.015625 GF

0.984375 GF = $280,000

GF = $284,444

Then,

Maintenance = $100,000 + 0.15625 ($284,444) = $144,444

Using the newly calculated amounts for GF and Maintenance and the allocation ratios, fill in the following table to allocate support department costs to the producing departments. (Round all allocated amounts to the nearest dollar. Leave cells blank that do not require an entry.)

Maintenance

GF

Cutting

Sewing

Direct overhead cost

$100,000

$270,000

$56,400

$75,000

Allocate:

General Factory

_

_

_

_

Maintenance

_

_

_

_

Total after allocation

_

_

_

_

Notice that after allocation, zero dollars remain in the support departments and all overhead cost has been allocated to the producing departments. As a check on your work, add all direct overhead costs from the first line - it equals $501,400. Then add the totals after allocation - again, it equals $501,400.