Key Topics: Operating and support departments Cost allocation methods Single versus dual rate allocations

1. Chapter 8Measuring and Assigning Support Department Costs Key Topics: Operating and support departments Cost allocation methods Single versus dual rate allocations Uncertainties in and quality of allocation information

2. What Are Support Departments, andWhy Are Their Costs Allocated to Other Departments? • Operating Departments Operating departments are the departments or divisions within an organization that manufacture goods or produce services for external customers or clients. • Support Departments Support departments provide services internal to the organization and that support the operating departments

3. Objectives for Allocating Support Department Costs

4. What Process Is Used to Allocate Support Department Costs? 1. Clarify the purpose of the allocation 2. Identify support and operating department cost pools 3. Assign costs to cost pools 4. For each support department cost pool, choose an allocation base 5. Choose and apply a method for allocating support department costs to operating departments 6. If relevant, allocate support costs from the operating departments to units of goods or services.

5. Allocation from Support Departments to Operating Departments and Then to Units of Goods or Services

6. Direct Method • Each support department's cost is allocated to only the operating departments. • Pros and Cons * Easiest method computationally, but computers make this factor less important * Easy to explain to managers and others * Ignores interactions among support departments

7. Step-Down Method • Support department costs are allocated one department at a time to remaining support and operating departments in a cascading manner until all support department costs have been allocated. • Pros and Cons * Requires ranking of support departments in terms of services provided to other support departments * Moderately easy computations, depending on the number of support departments * Moderately easy to explain to managers and others * Takes into account some of the interactions among support departments

8. Reciprocal Method • Support department costs are simultaneously allocated among support departments. • Support department costs, including interactions, are allocated to operating departments. • Pros and Cons * Computationally the most complex, but computers simplify the process * May be difficult to explain to managers and others * Most accurate allocation method, because it takes into account all of the interactions among support departments

9. Lake County Library

10. Using the Methods

11. What Is the Difference Between Single and Dual-Rate Allocations? • Single Rate Allocation Use only one base to allocate both fixed and variable costs • Dual Rate Allocation • Accumulate in separate cost pools and use different allocation bases for fixed and variable costs • Pros and Cons of Dual Rate Allocation • Reduces mismeasurement of allocation • Reduces misunderstandings about the behavior of support costs • Costs more to develop and maintain • May introduce additional mismeasurement from problems in classifying costs as fixed and variable

12. Uncertainties • Identifying support and operating cost pools • Assigning costs to cost pools • Selecting allocation bases • Choosing an allocation method • Measuring the degree of services provided among support departments (step-down and reciprocal methods)

13. Ways to Improve the Quality of Information • Dual rate allocations • Redesign of accounting system for cost pools and allocation bases • Choices regarding estimated versus actual support costs and rates • Consideration of perceived fairness • Imposition of allocation rules by contracting parties • Replacement of cost-based payments with fixed fee payments