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I'm Larry Walther, this is principlesofaccounting.com, Chapter 23.
And in this module we will consider the allocation of service department costs.
A service department would be something within the organization,
probably within the manufacturing or supporting the manufacturing area.
Such as janitorial support services, maintenance, cafeteria functions,
perhaps there's a worker clinic for health care issues, things of that nature.
So not all discrete units within a business organization
are focused on the production of the end product.
The cost of these services are allocated to products, however,
to measure the full cost of producing a product.
Remember for external reporting we're required to use absorption cost and
it takes into account all of the manufacturing costs,
the manufacturing overhead in other words.
And so there's two methods we're gonna look at for
allocating service department costs.
The first is the direct method which transfers the cost of a service department
directly to the productive departments that rely on those services.
It's usually based on a logical bench mark such as the cost of
janitorial services based on square footage
of different departments that are in the manufacturing process.
The cafeteria cost might be allocated based on the number of employees
in each particular manufacturing area.
And so let's look at example.
Benjamin Printing has two production departments,
the printing department that's highly automated and
the binding department which relies on a more manual labor-intensive process.
The departments are supported by a maintenance department and
a cafeteria department.
We decide and conclude that maintenance activities are driven by the amount
of machinery requiring support and
cafeteria services directly related to the number of employees.
So here's what looks like to be a fairly tedious or lengthy or
detailed spreadsheet but across the top row is simply the cost of each operation.
The cafeteria costs $600,000 to operate, maintenance costs $900,000 to operate,
and then the production costs related to printing and
binding were $3,700,000 and $2,500,000 respectively.
Let's focus on the cafeteria, the cafeteria cost $600,000.
We're going to directly allocate that cost to printing and binding,
our 2 productive departments, $150,000 to printing and $450,000 to binding.
We did that based on number of employees in each productive department.
Printing employed 5 persons and Binding employed 15 persons.
So on a pro-rata basis, 5/20 of the total cost goes to printing and
15/20 of the total cost goes to binding.
On the bottom portion of this slide or
the supporting calculations, this schedule is exactly reproduced in your textbook.
We will do the same thing for maintenance.
Notice we're allocating maintenance directly to printing and binding and
then totaling up, cafeteria and maintenance have been zeroed out.
So there's no unallocated cost from the service departments and printing and
binding have been boosted respectively by those particular cost,
to get the total cost of our printing activities and our binding activities.
The direct approach ignores an important facet however, and
that is service departments may support each other.
For example, Benjamin's maintenance employees also eat in the cafeteria.
So let's see how we mitigate this issue under the step method.
And identified service department's cost is first allocated to other units
including other service departments.
Then those result in cost are excessively step out to production and
an illustration best shows this.
We're going to keep our same costs here, the cafeteria maintenance, printing, and
binding start with the same cost.
But now the cafeteria cost of $600,000 is allocated not only to printing and
binding, but also to the maintenance department,
based on the number of employees in each department.
So we're stepping out that cost to maintenance, printing, and binding.
After making that step allocation, the maintenance department has a total cost of
a million one that's then allocated to printing and
binding based on the number of machines in use in each particular department.
Once we et through making this allocation,
we come up with 4,625,000 of the total cost in printing and 3,075,000 to binding.
Again, the lower portion of this shows the calculations for
each of those allocations.
This is in your textbook, you might want to look closer at that and test
the mathematics to be sure you understand the process that's being followed.
Now one thing the step method fails to consider is that
some of the maintenance employees may be providing services to the cafeteria.
That is some of the maintenance cost may be absorbed by the cafeteria.
We can get into a simultaneous allocation system.
I say it is quite possible to identify a number of
interactions between various service departments.
There's no mathematical limit to the number of step allocations that
could be made.
And we could indeed use calculus to achieve numerous simultaneous
applications.
However, companies are usually content to rely on direct or
very simplified step allocation process such as that I've just
shown illustrated.
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