In both the single-rate and dual-rate methods, Robinson uses budgeted rates to assign support department costs (fixed as well as variable costs) to user departments. An alternative approach would be to use actual rates based on the support costs realized during the period. This method is much less common because it imposes uncertainty on user departments. When allocations are made using budgeted rates, managers of departments to which costs are allocated know with certainty the rates to be used in that budget period. Users can then determine the amount of the service to request and—if company policy allows—whether to use the internal resource or an external vendor. In contrast, when actual rates are used for cost allocation, user department managers do not know the costs allocated to the departments until the end of the budget period.
Budgeted rates also help motivate the manager of the support (or supplier) department to improve efficiency. The support department, not the user departments, bears the cost of any unfavorable variances. User departments do not pay for any costs or inefficiencies of the supplier department that cause actual rates to exceed budgeted rates.
The manager of the supplier department would likely view budgeted rates negatively if unfavorable cost variances occur due to price increases outside his or her control. Some organizations try to identify these uncontrollable factors and do not hold the support department manager responsible for these variances. In other organizations, the supplier department and the user department agree to share the risk (through an explicit formula) of a large, uncontrollable increase in the prices of inputs of the supplier department. This avoids imposing risk completely on the supplier department (when budgeted rates are used) or the user department (when actual rates are used).
For the rest of this chapter, we focus only on allocation methods based on budgeted rates.
In both the single-rate and dual-rate methods, variable costs are assigned on the basis of budgeted rates and actual usage because variable costs are directly and causally linked to usage. Allocating variable costs on the basis of budgeted usage would provide user departments with no incentive to control consumption of support services.
What about fixed costs? Consider the $144,000 budgeted fixed costs of the Materials Management Department of Robinson Company. Budgeted usage is 800 hours for the Machining Department and 2,800 hours for the Assembly Department. Assume that actual usage of the Machining Department equals budgeted usage. Consider three cases:
Case 1: Actual usage by the Assembly Department equals budgeted usage.
Case 2: Actual usage by the Assembly Department is greater than budgeted usage.
Case 3: Actual usage by the Assembly Department is lower than budgeted usage.