We illustrate this approach using the 4,000 hours of practical capacity of the Materials Management Department. The budgeted rate is then determined as follows:
The table depicts the budgeted rate using the allocation based on the supply of capacity approach. The details of the table are as follows:
Budgeted fixed-cost rate per hour, 144,000 dollars divided by 4,000 hours: 36 dollars per hour
Budgeted variable-cost rate per hour: 30 dollars per hour
Budgeted total-cost rate per hour: 66 dollars per hour
Using the same procedures for the single-rate and dual-rate methods as in the previous section, Materials Management Department costs allocated to operating departments are as follows:
The table depicts Materials Management Department costs allocated to operating departments under the single-rate method. The details of the table are as follows:
1. Machining Department, 66 dollars per hour times 1,200 (actual) hours: 79,200 dollars
2. Assembly Department, 66 dollars per hour times 2,400 (actual) hours: 158,400 dollars
3. Fixed costs of unused Materials Management Department capacity, 36 dollars per hour times 400 hours: 14,400 dollars
(Note that 400 hours equals practical capacity of 4,000 minus the quantity of 1,200 hours used by Machining Department plus 2,400 hours used by Assembly Department.)
4. Total Materials Management Department costs: 252,000 dollars
The table depicts Materials Management Department costs allocated to the machining department under the dual-rate method. The details of the table are as follows:
Fixed costs, 36 dollars per hour times 800 (budgeted) hours: 28,800 dollars
Variable costs, 30 dollars per hour times 1,200 (actual) hours: 36,000 dollars
Total costs: 64,800 dollars
The table depicts Materials Management Department costs allocated to the assembly department under the dual-rate method, as well as totals. The details of the table are as follows:
1. Assembly department
2. Fixed costs of unused Materials Management Department capacity, 36 dollars per hour times 400 hours: 14,400 dollars
(Note that 400 hours equals practical capacity of 4,000 hours minus the quantity of 800 hours budgeted to be used by Machining Department plus 2,800 hours budgeted to be used by Assembly Department.)
4. Total Materials Management Department costs (64,800 dollars plus 172,800 dollars plus 14,400 dollars): 252,000 dollars
When a company uses practical capacity to allocate costs, the single-rate method allocates only the actual fixed-cost resources used by the Machining and Assembly Departments, while the dual-rate method allocates the budgeted fixed-cost resources to be used by the operating departments. Cost of unused Materials Management Department resources are highlighted but not allocated to departments.*
Using practical capacity to allocate costs focuses management’s attention on managing unused capacity (see Chapter 9 and Chapter 13). Using practical capacity also avoids burdening the user departments with the cost of unused capacity of the Materials Management Department. In contrast, allocating costs on the basis of the demand for materials-handling services, assigns all $144,000 of budgeted fixed costs, including the cost of unused capacity, to user departments. If costs are used as a basis for pricing, charging user departments for unused capacity could result in the downward demand spiral (see Chapter 9).
Resource consumption accounting (RCA), a management accounting system, employs an allocation procedure similar to a dual-rate system. For each cost/resource pool, cost assignment rates for fixed costs are based on practical capacity supplied, while variable costs of a resource pool use a budgeted rate.*
We next discuss advantages and disadvantages of the single-rate and dual-rate methods.