Chapter 5, Problem 2PB

Support activity cost allocation

Kizzle’s Crepes Co. produces world famous crepes. The company’s crepes are produced via its Mixing and Cooking activities, which both rely on the Janitorial and Maintenance activities. Kizzle’s management knows the most practical driver of Janitorial costs is square feet, but is uncertain whether to allocate Maintenance costs based on asset value of production equipment, number of service calls, or machine hours. Kizz1e’s management estimates that the Cooking and Mixing activities each require about twice as much space as the Maintenance activity.

Instructions

1. What factors should Kizzle’s management consider in choosing the driver to use for the allocation of Maintenance costs? Of the three potential drivers mentioned in the problem, which one(s) should Kizz1e’s most likely not use?

2. Assume that Kizzle’s management allocates Maintenance costs based on the number of service calls. Further assume that in a given period, the Janitorial, Mixing, and Cooking activities incur 16, 40, and 24 service calls, respectively, and that the Janitorial and Maintenance costs of that period are $3,000 and $4,200, respectively. Determine the total costs allocated from each support activity to the other three activities using the reciprocal services method.

3. Kizz1e’s Crepes Co. is expanding rapidly due to its exponentially growing sales and popularity. Kizzle’s management is worried that as the company expands, its current method of support activity cost allocation, the reciprocal services method, may become too burdensome. Is this true? If so, what alternative method should Kizzle’s Crepes Co. use as it expands?

To determine

Identify the cost driver to allocate maintenance costs and whether or not to use the machine hours as the cost driver.

Explanation of Solution

Cost Driver: The cost driver refers to the all the activities on which the money is spent to produce the product or the service. It has a cause-effect relationship with the resources utilized in production. The cost drivers are used to form the activity cost pools.

The support department costs in the production are the indirect costs that difficult to identify and be associated to the concerned cost drivers. Hence, it is difficult to apply support department costs to the products.

Asset value is not an accurate cost driver and must not be used. Square footage must be used as it a more appropriate cost driver as maintenance department is associated more with the usage and repair rather than the asset value.

To determine

Compute the total cost of each production department after allocating all support costs to the production departments using the cost driver chosen in part a.

Explanation of Solution

Maintenance Department Cost to be allocated:

The total Maintenance Department costs include 20% of the Janitorial department costs as,

$\frac{1}{\left(1+2+2\right)}$.

Therefore, the Janitorial Department cost is,

$\text{Maintenance department = \$4,200 + }\left(\text{0}\text{.2}\times \text{J}\right)$

Janitorial Department Cost to be allocated:

The total Janitorial Department costs include 20% of the Maintenance department costs as,

$\frac{16}{\left(16+40+24\right)}$.

Therefore, the Janitorial Department cost is,

$\text{Janitorial department = \$3,000 + }\left(\text{0}\text{.2}\times \text{M}\right)$

Substitute the equation for M into the J equation:

$\begin{array}{c}\text{Janitorial department = \$3,000 + }\left[\text{0}\text{.2}\times \left[\text{\$4,200 + }\left(\text{0}\text{.2}\times \text{J}\right)\right]\right]\\ =\text{\$3,000 +\$840 + }\left(\text{0}\text{.04}\times \text{J}\right)\\ 0.96\times \text{J}=\text{\$3,840}\\ \text{= \$4,000}\end{array}$

Substitute the value of J into the M equation:

$\begin{array}{c}\text{Maintenance department = \$4,200 + }\left(\text{0}\text{.2}\times \text{\$4,000}\right)\\ =\text{\$4,200 +\$800 }\\ \text{= \$5,000}\end{array}$

Maintenance Department Cost Allocation:

Compute the allocation of costs from Maintenance Department to Janitorial Department:

$\begin{array}{c}\begin{array}{l}\text{Maintenance }\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Janitorial Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Maintenance Department}\end{array}\right)\\ \text{=}\left(\frac{16}{\left(16+40+24\right)}\times 100\right)\times \$5,000\\ =20\%\times \$5,000\\ =\$1,000\end{array}$

The cost allocated from Maintenance Department to Janitorial Department is $1,000.

Compute the allocation of costs from Maintenance Department to Mixing Department:

$\begin{array}{c}\begin{array}{l}\text{Maintenance }\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Mixing Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Maintenance Department}\end{array}\right)\\ \text{=}\left(\frac{40}{\left(16+40+24\right)}\times 100\right)\times \$5,000\\ =50\%\times \$5,000\\ =\$2,500\end{array}$

The cost allocated from Maintenance Department to Mixing Department is $2,500.

Compute the allocation of costs from Maintenance Department to Cooking Department:

$\begin{array}{c}\begin{array}{l}\text{Maintenance }\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Cooking Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Maintenance Department}\end{array}\right)\\ \text{=}\left(\frac{24}{\left(16+40+24\right)}\times 100\right)\times \$5,000\\ =30\%\times \$5,000\\ =\$1,500\end{array}$

The cost allocated from Maintenance Department to Cooking Department is $1,500.

Janitorial Department Cost Allocation:

Compute the allocation of costs from Janitorial Department to Maintenance Department:

$\begin{array}{c}\begin{array}{l}\text{Janitorial}\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Maintenance Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Janitorial Department}\end{array}\right)\\ \text{=}\left(\frac{1}{\left(1+2+2\right)}\times 100\right)\times \$4,000\\ =20\%\times \$4,000\\ =\$800\end{array}$

The cost allocated from Janitorial Department to Maintenance Department is $800.

Compute the allocation of costs from Janitorial Department to Mixing Department:

$\begin{array}{c}\begin{array}{l}\text{Janitorial}\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Mixing Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Janitorial Department}\end{array}\right)\\ \text{=}\left(\frac{2}{\left(1+2+2\right)}\times 100\right)\times \$4,000\\ =40\%\times \$4,000\\ =\$1,600\end{array}$

The cost allocated from Janitorial Department to Mixing Department is $1,600.

Compute the allocation of costs from Janitorial Department to Cooking Department:

$\begin{array}{c}\begin{array}{l}\text{Janitorial}\\ \text{Department}\end{array}\}\text{ =}\left(\frac{\text{Cooking Department}}{\text{Total cost driver}}\times 100\right)\times \left(\begin{array}{l}\text{Total costs of}\\ \text{Janitorial Department}\end{array}\right)\\ \text{=}\left(\frac{2}{\left(1+2+2\right)}\times 100\right)\times \$4,000\\ =40\%\times \$4,000\\ =\$1,600\end{array}$

The cost allocated from Janitorial Department to Cooking Department is $1,600.

To determine

Suggest the need to change the cost allocation method and the best method, if the existing method needs to be changed during expansion.

Explanation of Solution

The switch from the existing method of sequential method to other methods is not recommended as this is the most accurate method of allocating the costs. When there is a plan for expansion, this method would be the most recommended as it is efficient in allocating the costs to the various departments.