Allocating Costs of Multiple Support Departments

Learning Objective 3 Allocate multiple support-department costs using the direct method, the step-down method, and the reciprocal method

•  allocates support-department costs directly to operating departments
• partially allocates support-department costs to other support departments
• fully allocates support-department costs to other support departments

In this section, we consider multiple support departments and the cost-allocation problems that arise when two or more support departments provide reciprocal support to each other and to operating departments. An example of reciprocal support of support departments is Robinson’s Materials Management Department providing materials-handling labor services to all other departments, including the Engineering and Production Control Department, while also utilizing the services of the Engineering and Production Control Department for managing materials-handling equipment and scheduling materials movement to the production floor. More accurate support-department cost allocations result in more accurate product, service, and customer costs.

Exhibit 16-2, column 6, provides details of Robinson’s total budgeted manufacturing overhead costs of $1,120,000 for 2020 (see Chapter 4, General Approach to Job Costing Using Normal Costing), for example, supervision salaries, $200,000; depreciation and maintenance, $193,000; indirect labor, $195,000; and rent, utilities, and insurance, $160,000. Robinson allocates the $1,120,000 of total budgeted manufacturing overhead costs to the Machining and Assembly Departments in several steps.

1. Step A: TRACE OR ALLOCATE EACH COST TO VARIOUS SUPPORT AND OPERATING DEPARTMENTS. Exhibit 16-2, columns 1 through 5, show calculations for this step. For example, supervision salaries are traced to the departments in which the supervisors work. As described in Chapter 2, Factors Affecting Direct/Indirect Cost Classifications,  supervision costs are an indirect cost of individual jobs because supervisory costs cannot be traced to individual jobs. They are a direct cost of the different departments, however, because they can be identified with each department in an economically feasible way. Rent, utilities, and insurance costs cannot be traced to each department because these costs are incurred for all of Robinson’s manufacturing facility. These costs are therefore allocated to different departments on the basis of the square feet area—the cost driver for rent, utilities, and insurance costs (Row 9).
2. Step B: ALLOCATE PLANT ADMINISTRATION COSTS TO OTHER SUPPORT DEPARTMENTS AND OPERATING DEPARTMENTS. Plant administration supports supervisors in each department, so plant administration costs are allocated to departments on the basis of supervision costs.
3. Some companies prefer not to allocate plant administration costs to jobs, products, or customers because these costs are fixed and independent of the level of activity in the plant. However, most companies, like Robinson, allocate plant administration costs to departments and jobs, products, or customers to calculate the full manufacturing costs of products. Robinson calculates the plant administration cost-allocation rate as follows:

1. In Step B of Exhibit 16-2, Robinson uses the 0.50 cost-allocation rate and supervision salaries to allocate plant administration costs to other support and operating departments.
2. Step C: ALLOCATE ENGINEERING AND PRODUCTION CONTROL AND MATERIALS MANAGEMENT COSTS TO THE MACHINING AND ASSEMBLY OPERATING DEPARTMENTS. The two support departments whose costs are being allocated—Engineering and Production Control and Materials Management—provide reciprocal support to each other and to operating departments. That is, the Engineering and Production Control Department serves the Materials Management Department (for example, engineering services for materials-handling equipment and scheduling material movements), while the Materials Management Department serves the Engineering and Production Control Department (for example, delivering materials).

We describe three methods of allocatingConsider the Materials Management Department. From Exhibit 16-2, the total budgeted cost of the Materials Management Department equals $264,000. We can also calculate this cost using the fixed and variable cost classification of the previous section. The Materials Management Department is budgeted to provide 800 hours of materials-handling labor services to the Machining Department and 2,800 hours of materials-handling labor services to the Assembly Department. In this section, we further assume that the Materials Management Department will provide an additional 400 hours of materials-handling labor services to the Engineering and Production Control Department. Recall from the previous section that the Materials Management Department has budgeted fixed costs (for example, plant administration, depreciation, and rent) of $144,000 and budgeted variable costs (for example, indirect materials, indirect labor, and maintenance) of $30 per labor-hour. Total budgeted costs of the Materials Management Department equals $\mathrm{\$}\text{264,000\hspace{0.17em}}[\mathrm{\$}1\text{44,000}+\mathrm{\$}30\text{\hspace{0.17em}per\hspace{0.17em}labor-hour}\times (800+2\text{,}800+400\left)\text{\hspace{0.17em}labor-hours}\right]$ as shown in Exhibit 16-2.^*

Exhibit 16-3 displays the data for budgeted overhead costs from Exhibit 16-2 after allocating Plant Administration Department costs but before any further interdepartment cost allocations for services provided by each support department to other departments. To understand the percentages in this exhibit, consider the Engineering and Production Control Department. This department supports the engineering activity in the other departments and so the budgeted costs of this department are allocated to the other departments based on budgeted engineering salaries— Materials Management Department, $36,000; Machining Department, $60,000; and Assembly Department, $24,000 for a total of $\$\text{120,000}(\$\text{36,000}+\$\text{60,000}+\$\text{24,000})$ (see Exhibit 16-3). The Engineering and Production Control Department is budgeted to provide support of $30\%(\mathrm{\$}\text{36,000}÷\mathrm{\$}\text{120,000}=0.30)$ to the Materials Management Department, $50\text{\%}(\text{\$}60\text{,}000÷\text{\$}120\text{,}000=0.50)$ to the Machining Department, and $20\text{\%\hspace{0.17em}}(\text{\$}24\text{,}000÷\text{\$}120\text{,}000=0.20)$ to the Assembly Department. Similarly, the Materials Management Department is budgeted to provide a total of 4,000 material handling labor-hours of support work: $10\text{\%\hspace{0.17em}}(400÷4\text{,}000=0.10)$ for the Engineering and Production Control Department, $20\text{\%\hspace{0.17em}}(800÷4\text{,}000=0.20)$ for the Machining Department, and $70\text{\%\hspace{0.17em}}(2\text{,}800÷4\text{,}000=0.70)$ for the Assembly Department.

We describe three methods of allocating budgeted overhead costs from the support departments to the operating departments: direct, step-down, and reciprocal. We use budgeted costs and budgeted hours of the operating and support departments to calculate the budgeted costs of the operating departments (Machining and Assembly) after allocation of support departments’ (Materials Management and Engineering and Production Control) costs. The budgeted costs of the Machining Department are divided by the budgeted machine-hours in the Machining Department (the cost driver of Machining Department costs) and the budgeted costs of the Assembly Department are divided by the budgeted direct manufacturing labor-hours in the Assembly Department (the cost driver of Assembly Department costs) to calculate the budgeted overhead allocation rates for each operating department. These overhead rates are used to allocate overhead costs to each job as it passes through an operating department based on actual machine-hours used in the Machining Department and actual direct manufacturing labor-hours used in the Assembly Department. To simplify the explanation and to focus on concepts, we use the single-rate method to allocate the costs of each support department. (The Problem for Self-Study [in the End of Chapter section] illustrates the dual-rate method for allocating reciprocal support-department costs.)

Direct Method

The direct method allocates each support-department’s budgeted costs directly to only operating departments. Support department costs are not allocated to other support departments. Exhibit 16-4 illustrates this method using the data in Exhibit 16-3. The base used to allocate Engineering and Production Control costs to operating departments is the budgeted engineering salaries in the operating departments: $\text{\$}60\text{,}000+\text{\$}24\text{,}000=\text{\$}84\text{,}000\text{.}$ This amount excludes the $36,000 of budgeted engineering salaries in the Materials Management Department. The budgeted cost of the Engineering and Production Control Department of $300,000 is allocated to the Machining Department and the Assembly Department in the ratio $(\mathrm{\$}\text{60,000}÷\mathrm{\$}\text{84,000},$ $\text{\$}24\text{,}000÷84\text{,}000)$ or $(5/7\text{,} 2/7)$. The Machining Department is allocated $5\text{/}7\times \text{\$}300\text{,}000=\text{\$}214\text{,}286$ and the Assembly Department is allocated $2\text{/}7\times \text{\$}300\text{,}000=\text{\$}85\text{,}714\text{.}$ Similarly, the base used to allocate the budgeted cost of the Materials Management Department to the operating departments is $800+2\text{,}800=3\text{,}600$ budgeted materials-handling labor-hours in the operating departments, excluding the 400 budgeted materials-handling labor-hours in the Engineering and Production Control Department.

An equivalent approach to implementing the direct method is to calculate a budgeted rate for each support department. For example, the budgeted cost rate for the Engineering and Production Control Department is $(\$\text{300,000}÷\$\text{84,000}),$ or 357.143%. The Machining Department is then allocated $\text{\$}214\text{,}286(357.143\text{\%}\times \text{\$}60\text{,}000)\text{,}$ while the Assembly Department is allocated $\text{\$}85\text{,}714(357.143\text{\%}\times \text{\$}24\text{,}000)\text{.}$ For ease of computation and explanation throughout this section, we use the fraction of the support department services used by other departments to allocate support department costs, rather than budgeted cost rates.

The direct method is simple and easy to use. Managers do not need to predict the usage of support department services by other support departments. Its disadvantage is that it ignores information about reciprocal services provided among support departments and can therefore lead to inaccurate estimates of the cost of operating departments. We next examine a second approach, which partially recognizes the services provided among support departments.