Fixed-Cost Allocation Based on Budgeted Rates and Actual Usage

Column 2 of Exhibit 16-1 shows the allocations when the budgeted rate is based on budgeted usage ($40 per hour), while column 3 shows the allocations when practical capacity is used to derive the budgeted rate ($36 per hour). Note that each operating department’s fixed-cost allocation varies based on its actual usage of support facilities. However, variations in actual usage in one department do not affect the costs allocated to the other department. The Machining Department is allocated either $32,000 or $28,800, depending on the budgeted rate chosen, independent of the Assembly Department’s actual usage.

Exhibit 16-1 

Effect of Variations in Actual Usage on Fixed-Cost Allocation to Operating Divisions

Table shows the actual usage, budgeted rate, and budgeted total fixed costs for three cases and their calculations.

Details of each of the three cases are as follows:

Case 1:

  1. Actual usage

    • Machining department: 800 hours

    • Assembly department: 2,800 hours

  2. Budgeted rate based on budgeted usage (which is $144,000 divided by the sum of 800 and 2,800 hours which equals $40 per hour)

    • Machining department: $32,000

    • Assembly department: $112,000

  3. Budgeted rate based on actual usage practical capacity (which is $144,000 divided by 4,000 hours equals $36 per hour)

    • Machining department: $28,800

    • Assembly department: $100,800

  4. Allocation of budgeted total fixed cost

    • Machining department: $32,000 (which is 800 divided by the sum of 800 and 2,800 and the result multiplied by $144,000)

    • Assembly department: $112,000 (which is 2,800 divided by the sum of 800 and 2,800 and the result multiplied by $144,000)

Case 2:

  1. Actual usage

    • Machining department: 800 hours

    • Assembly department: 3,200 hours

  2. Budgeted rate based on budgeted usage (which is $144,000 divided by the sum of 800 and 2,800 hours which equals $40 per hour)

    • Machining department: $32,000

    • Assembly department: $128,000

  3. Budgeted rate based on actual usage practical capacity (which is $144,000 divided by 4,000 hours equals $36 per hour)

    • Machining department: $28,800

    • Assembly department: $115,200

  4. Allocation of budgeted total fixed cost

    • Machining department: $28,800 (which is 800 divided by the sum of 800 and 3,200 and the result multiplied by $144,000)

    • Assembly department: $115,200 (which is 3,200 divided by the sum of 800 and 3,200 and the result multiplied by $144,000)

Case 3

  1. Actual usage

    • Machining department: 800 hours

    • Assembly department: 2,400 hours

  2. Budgeted rate based on budgeted usage (which is $144,000 divided by the sum of 800 and 2,800 hours which equals $40 per hour)

    • Machining department: $32,000

    • Assembly department: $96,000

  3. Budgeted rate based on actual usage practical capacity (which is $144,000 divided by 4,000 hours equals $36 per hour)

    • Machining department: $28,800

    • Assembly department: $86,400

  4. Allocation of budgeted total fixed cost

    • Machining department: $36,000 (which is 800 divided by the sum of 800 and 2,400 and the result multiplied by $144,000)

    • Assembly department: $108,000 (which is 2,400 divided by the sum of 800 and 2,400 and the result multiplied by $144,000)

This allocation procedure for fixed costs is exactly the same as the allocation procedure under the single-rate method. The procedure therefore shares the advantages of the single-rate method, such as advanced knowledge of budgeted rates, as well as control over the costs charged to the operating departments based on actual usage.*

The procedure in column (2) also shares the disadvantages of the single-rate method discussed in the previous section. When the budgeted rate (of $40 per hour) is calculated based on budgeted usage, user departments are charged for the cost of unused capacity. Consider Case 1 when actual usage equals budgeted usage of 3,600 materials-handling labor-hours and is less than the practical capacity of 4,000 labor-hours. In this case, all  $144,000 ($32,000 + $112,000) of fixed costs of the Materials Management Department are allocated to the operating departments even though the Materials Management Department has idle capacity. On the other hand, when actual usage (4,000 labor-hours) is more than the budgeted amount (3,600 labor-hours) as in Case 2, a total of  $160,000 ($32,000 + $128,000) is allocated, which is more than the fixed costs of $144,000. This results in overallocation of fixed costs requiring end-of period adjustments, as discussed in Chapters 4 and 8. If, however, practical capacity is used to calculate the budgeted rate (of $36 per hour), as in column (3), user departments are only charged for the actual resources of the Materials Management Department used by the operating departments and not for the costs of unused capacity.

As noted earlier, allocating fixed costs based on actual usage induces conflicts of interest when evaluating outsourcing possibilities. The Machining and Assembly Departments can reduce fixed costs allocated to them by reducing the actual usage of Materials Management Department services. That’s because the allocated fixed costs of the Materials Management Department appear as variable costs to the operating departments. From the point of view of the company as a whole, however, the fixed costs of the Materials Management Department will not be saved if the operating departments do not use the services of the Materials Management Department. Any variable cost paid to an outside supplier, even if it is lower than the allocated fixed costs, will increase Robinson’s total costs.