As stated previously, the direct method ignores the provision of services by one service department to another service department.
This shortcoming is overcome partially by the step-down method of service department cost allocation.
Under this method, the managerial accountant first chooses a sequence in which to allocate the service costs.
A common way to select the first service department in the sequence is to choose the one that serves the largest number of other service departments.
The departments are ordered in this manner, with the last service department being the one that serves the smallest number of other service departments.
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Allocation of Support Activity Costs and Joint CostsChapter 17Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Service Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)ProductionDepartment(Machining)ProductionDepartment(Assembly)The ProductSecond Stage AllocationsProduction department overhead costs, plus allocated service department costs, are applied to products using departmental predetermined overhead rates.Service Department Cost AllocationFirst Stage AllocationsService department costs are allocated to production departments.17-2Selecting Allocation BasesPersonnel:Number ofemployeesReceiving:UnitshandledSecurity:SquarefootagePower:KilowatthoursCafeteria:Number ofemployeesCustodial:SquarefootageAccounting:StaffhoursTypicalAllocationBases17-3Selecting Allocation BasesCriteria forselectionPersonnel:Number ofemployeesReceiving:UnitshandledSecurity:SquarefootagePower:KilowatthoursCafeteria:Number ofemployeesCustodial:SquarefootageAccounting:StaffhoursSimplicityAvailabilityof space orequipmentBenefits receivedby the productiondepartment 17-4Interdepartmental ServicesService Department(Cafeteria)Service Department(Custodial)ProductionDepartment(Machining)ProductionDepartment(Assembly)POWER DEPARTMENT17-5Interdepartmental ServicesProblemAllocating costs when service departmentsprovide services to each otherSolutionsDirect MethodStep-Down Method17-6Direct MethodService Department(Cafeteria)Service Department(Custodial)ProductionDepartment(Machining)ProductionDepartment(Assembly)Cost of servicesbetween servicedepartments areignored and allcosts areallocated directlyto productiondepartments.For an example please see the textbook.17-7Step-Down MethodService Department(Cafeteria)Service Department(Custodial)ProductionDepartment(Machining)ProductionDepartment(Assembly)Service departmentcosts are allocatedto other servicedepartments andto productiondepartments, usuallystarting with theservice departmentthat serves thelargest number of other service departments. 17-8Step-Down MethodService Department(Cafeteria)Service Department(Custodial)ProductionDepartment(Machining)ProductionDepartment(Assembly)Once a servicedepartment’s costsare allocated, other servicedepartments’ costsare not allocatedback to it. 17-9Step-Down MethodService Department(Cafeteria)Service Department(Custodial)ProductionDepartment(Machining)ProductionDepartment(Assembly)Custodial willhave a newtotal to allocateto productiondepartments: itsown costs plusthose costsallocated fromthe cafeteria. For an example please see the textbook.17-10Charge toproductiondepartments at abudgeted rate timesactual short-run usage of the allocation base.Allocatebudgeted amountsto operating departmentsin proportion to thelong-run averageusage of theallocation base. Budgeted costs should be allocated to avoid passing on inefficienciesfrom the service departments.Dual Cost Allocation17-11SimCo has a maintenance department and two productiondepartments: cutting and assembly. Variable maintenancecosts are budgeted at $0.60 per machine hour. Fixedmaintenance costs are budgeted at $200,000 per year.Data relating to the current year are: Allocate maintenance costs to the two operating departments.Dual Cost AllocationExample17-12Variable costs are allocated based on hours used.Fixed costs are allocated based long-run average usage.Dual Cost AllocationExample17-13The New Manufacturing EnvironmentMore accurate cost tracing systemsreduce the need for allocationof indirect costs.17-14The Rise of Activity-Based CostingService Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)The ProductFirst stage allocations are toactivities, not departments.ActivityOneActivityTwo17-15SeparateProcessing CostsFinalSaleSeparateProcessingFinalSaleSeparateProcessingSeparateProcessing CostsJointInputJointProductionProcessSplit-OffPointJointProductCostsOilGasolineJoint Product Cost Allocation17-16Allocating Joint CostsJoint Product CostsPhysical-UnitsMethodRelative-Sales-Value MethodNet-Realizable-Value Method17-17Allocating Joint CostsAllocation based onthe relative valuesof the products at the split-off point. Allocation based on a physical measure of the joint products at the split-off point. Allocation based onfinal sales values lessseparable processingcosts.Relative-Sales-Value MethodPhysical-UnitsMethodNet-Realizable-Value Method17-18240,000 gallons360,000 gallonsJointProductionProcessSplit-OffPointOilGasolineJoint materialcost = $275,000Joint conversioncost = $225,000Physical-Units Method17-19Physical-Units Method$225,000 joint conversion cost plus$275,000 joint material cost17-20$200,000sales value atsplit-off point$600,000sales value atsplit-off pointJointProductionProcessSplit-OffPointOilGasolineJoint materialcost = $275,000Joint conversioncost = $225,000Relative-Sales-Value Method17-21$225,000 joint conversion cost plus$275,000 joint material costRelative-Sales-Value Method17-22Net-Realizable-Value Method If products require further processing beyond the split-off point before they are marketable, it may be necessary to estimate the net realizable value (NRV) at the split-off point.EstimatedNRV FinalSalesValueAddedProcessingCosts–=17-23Net-Realizable-Value MethodJointProductionProcessOilGasolineSeparateProcessingSeparateProcessingJoint materialcost = $275,000Joint conversioncost = $225,000SalesValue$500,000SalesValue$1,200,000Split-OffPoint, Sales Value UnknownSeparateProcessing Costs$500,000SeparateProcessing Costs$200,00017-24Net-Realizable-Value Method17-25Reciprocal-Services Method Fully accounts for reciprocal services More accurate Can be combined with dual allocation17-26
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