Chapter 11, Problem 55P

 Comparison of Allocation Methods

 BluStar Company has two service departments, Administration and Accounting, and two operating departments, Domestic and International. Administration costs are allocated on the basis of employees, and Accounting costs are allocated on the basis of number of transactions. A summary of BluStar operations follows:

Required

1. a.      Allocate the cost of the service departments to the operating departments using the direct method.
2. b.      Allocate the cost of the service departments to the operating departments using the step method. Start with Administration.
3. c.       Allocate the cost of the service departments to the operating departments using the reciprocal method.
4. d.      Comment on the results.

To determine

Allocate the cost of the service departments to the operating departments by using the direct method.

Answer to Problem 55P

The cost allocation to domestic unit is $1,036,800 and international unit is $4,003,200.

Explanation of Solution

Direct method:

Direct cost allocates cost directly to the production process of the business. This method assumes that the service department does not provide services to each other. So does not allocate cost to the service department of the business. All the service costs are directly charged to the end consumer by the way of allocating the cost to the production department.

Allocate the cost to the operating department:

	Department
Amount	Administration	Accounting	Domestic	International
Department cost	$360,000	$144,000	$936,000	$3,600,000
Administration (1)	$(360,000)	-	$72,000	$288,000
Accounting  (2)	-	$(144,000)	$28,800	$115,200
Total cost	$0	$0	$1,036,800	$4,003,200

Table: (1)

Thus, the cost allocation to the domestic unit is $1,036,800, and the international unit is $4,003,200.

Working note 1:

Calculate the allocation of maintenance cost:

Particulars	Administration cost (a)	Employees number (b)	Amount $\text{c = }\frac{\text{b}}{\text{Total of b}}\text{ × a}$
Allocation to administration cost :
Domestic	$360,000	45	$72,000
International	$360,000	180	$288,000
Total		$225

Table: (2)

Working note 2:

Calculate the allocation of accounting department:

Particulars	Accounting cost (a)	Transactions number (b)	Amount $\text{c = }\frac{\text{b}}{\text{Total of b}}\text{ × a}$
Allocation to accounting cost :
Domestic	$144,000	20,000	$28,800
International	$144,000	80,000	$115,200
Total		100,000

Table: (3)

To determine

Allocate the cost of the service departments to the operating departments by using the step method by starting with the Administration.

Answer to Problem 55P

The cost allocation to domestic unit is $1,036,800 and international unit is $4,003,200.

Explanation of Solution

Step method:

Step method allows the allocation of the cost to the production department and service departments. Unlike the direct method, it also allocates the cost of the service to various service departments. Allocation of the cost starts from the department that has provided the highest proposition of service to the department that has provided the least service. Step method allows only one-way allocation of cost among service departments.

Allocate the cost to the operating department:

	Department
Particulars	Administration	Accounting	Domestic	International
Department cost	$360,000	$144,000	$936,000	$3,600,000
Administration (1)	$(360,000)	$36,000	$64,800	$259,200
Accounting  (2)	-	$(180,000)	$36,000	$144,000
Total cost	$0	$0	$1,036,800	$4,003,200

Table: (4)

Thus, the cost allocation to the domestic unit is $1,036,800, and the international unit is $4,003,200.

Working note 3:

Calculate the allocation of maintenance cost:

Particulars	Administration cost (a)	Employees number (b)	Amount $\text{c = }\frac{\text{b}}{\text{Total of b}}\text{ × a}$
Allocation to administration cost :
Accounting	$360,000	25	$36,000
Domestic	$360,000	45	$64,800
International	$360,000	180	$259,200
Total		$250

Table: (5)

Working note 4:

Calculate the allocation of accounting department:

Particulars	Accounting cost (a)	Transactions number (b)	Amount $\text{c = }\frac{\text{b}}{\text{Total of b}}\text{ × a}$
Allocation to accounting   cost :
Domestic	$180,000	20,000	$36,000
International	$180,000	80,000	$144,000
Total		100,000

Table: (6)

To determine

Allocate the cost of the service departments to the operating departments by using the reciprocal method.

Answer to Problem 55P

The cost allocation to domestic unit is $1,036,800 and international unit is $4,003,200.

Explanation of Solution

Reciprocal method:

The reciprocal method recognizes the cost allocation to the service departments like step method. It allocates cost to the service department and production department of the business. Unlike the step method, the reciprocal method allows the two-way allocation of cost among the service department

Allocate the cost to the operating department:

	Department
Amount	Administration	Accounting	Domestic	International
Department cost	$360,000	$144,000	$936,000	$3,600,000
Administration (1)	$(396,735)	$39,674	$71,412	$285,649
Accounting  (2)	$36,735	$(183,674)	$29,388	$117,551
Total cost	$0	$0	$1,036,800	$4,003,200

Table: (7)

Thus, the cost allocation to the domestic unit is $1,036,800, and the international unit is $4,003,200.

Working note 5:

Calculate the allocation of maintenance cost:

Particulars	Administration cost (a)	Employees number (b)	Amount $\left(\text{c = }\frac{\text{b}}{\text{Total of b}}\text{× a}\right)$
Allocation to administration cost :
Accounting	$396,735	25	$39,674
Domestic	$396,735	45	$71,412
International	$396,735	180	$285,649
Total		$250

Table: (8)

Working note 6:

Calculate the allocation of accounting department:

Particulars	Accounting cost (a)	Transactions number (b)	Amount $\left(\text{c = }\frac{\text{b}}{\text{Total of b}}\text{ × a}\right)$
Allocation to accounting cost :
Administration	$183,674	25,000	$36,735
Domestic	$183,674	20,000	$29,388
International	$183,674	80,000	$117,551
Total		$125,000

Table: (9)

Working note 7:

Calculate the value of accounting and administration cost;

Set up a cost equation:

Let,

Administration cost: S1

Accounting cost: S2

Total service cos will be equal to the direct cost of the service department and cost allocated to the service department.

$\begin{array}{l}\text{S1 = \$360,000 + 0}\text{.20S2}\\ \text{S2 = \$144,000 + 0}\text{.10S1}\end{array}$

Putting the value of S1 in S2:

$\begin{array}{c}\text{S2 = \$144,000 + 0}\text{.10 (\$360,000 + 0}\text{.20 S2)}\\ \text{S2 = \$144,000 + \$36,000 + 0}\text{.02 S2}\\ \text{0}\text{.98 S2 = \$180,000}\\ \text{S2 = \$183,673}\end{array}$

Calculate the value of S1:

$\begin{array}{c}\text{S1 = \$360,000 + 0}\text{.20 (\$183,673)}\\ \text{S1 = \$396,735}\end{array}$

Thus, administration costs and accounting costs are $396,735 and $183,637 respectively.

To determine

Comment on the results.

Explanation of Solution

Comment on the cost allocation:

The allocation of the cost may differ, but the total allocated cost to the domestic and international department is the same.

So selecting a method will not result in the financial management of the business. The cost allocation will help the divisional manager to manage the cost of the division for the better performance of the division.