Ch. 8: Measuring and Assigning Support Department Costs

Reciprocal method

-allocates all support department costs to other support departments -Compute the total costs of each support department when its usage of other support department services is taken into consideration -Support department costs are then allocated to all other operating and support departments that consume its services

Direct Method

-ignores the fact that support departments use each others' services -Each support department's costs are allocated only to operating departments -Easiest method to compute and explain

Transfer Pricing

-When support departments charge user departments for their services Ex 1. Engineering works on a project with accounting and charges accounting for their hours worked (support depts.) Ex 2. One segment of the company produces parts that it sells to another segment of the company who assembles and sells the finished product -Transfer prices should be set to motivate efficient use of the support department resources

Why do we need to measure and assign support departments?

1. External Reporting (not GAAP) -Typically required by gov. agencies 2. Motivation -Provide incentives for efficient production of support services 3. Strategic or Operating Decisions -Pricing of products, insource/outsource

Methods to Allocating Support Department Costs

3 methods: 1. Direct method 2. Step-Down 3. Reciprocal Method Difference is how support dept. costs are allocated to operating depts. Important: The total support department costs stay the same, it's the amount allocated to each support / operating department that differs!

Steps to Allocating Support Department Costs

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.

Some organizations allocate support department costs to

I. Provide managers incentives for efficient production of SUPPORT services II. Provide managers incentives for appropriate and effective use of support services III. Monitor managers' use and production of support services

Replacing cost-based reimbursement contracts with fixed fee reimbursement contracts is one way to

Reduce the incentive to bias information when allocating support department costs

Decision Making and Incentives

Support costs need to be considered when evaluating decisions such as make/buy, keep/drop, special order, and constrained resource -Necessary to isolate relevant support costs, which may not be the same as the allocated support costs Ex. Outsourcing an operating department may not result in a reduction in support department costs -Support costs can be included in department budgets, which are often the basis for managers' performance evaluations

Step-down method

allocates some (but not all) support department costs to other support departments -First support department's costs are allocated to all operating and support departments that use its services -Subsequent support department's costs are allocated to all operating and support departments that use its services, except any support department whose costs were already allocated

Dual-rate allocation

support costs are separated into fixed and variable cost pools and drivers are identified for the variable cost pools - More accurately reflects the flow of resources -Possible mismeasurement due to more estimates involved -More costly

Primary objective

to Understand and allocate support department costs, which are period costs on the income statement for external reporting (GAAP)

Single-rate allocation

using only one base to allocate both fixed and variable costs - Likely mismeasures resources used - Furthers managers' incorrect beliefs that all support costs are variable