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3

Two Stage AllocationsTwo Stage Allocations

• Understand why the difference between production and service departments is important

• Understand allocation of service department costs to production departments

• Identify and use the two stages of cost allocations

• should know how conventional two-stage allocation methods often distort production costs

• use activity-based costing systems to estimate product costs

• assign selling and distribution costs to products

• Understand why the difference between production and service departments is important

• Understand allocation of service department costs to production departments

• Identify and use the two stages of cost allocations

• should know how conventional two-stage allocation methods often distort production costs

• use activity-based costing systems to estimate product costs

• assign selling and distribution costs to products

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Production DepartmentsProduction Departments

Those departments directly responsible

for some of the work of converting raw

materials into finished products

Those departments directly responsible

for some of the work of converting raw

materials into finished products

Examples of Production DepartmentsCasting

StampingMachiningAssemblyPacking

Examples of Production DepartmentsCasting

StampingMachiningAssemblyPacking

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Dekke

r, Ltd.Service DepartmentsService Departments

Those departments performing activities that support production, but are not responsible for any of the conversion stages

Examples of Service Departments

Machine maintenance

Machine setup

Production scheduling

Examples of Service Departments

Machine maintenance

Machine setup

Production scheduling

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The Conventional, Two-Stage Allocation MethodThe Conventional, Two-Stage Allocation Method

Stage 1:Indirect costs are identified with

production and service departments. These costs are then allocated to production

departments.

Stage 1:Indirect costs are identified with

production and service departments. These costs are then allocated to production

departments.

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Stage 2:The costs that have been

accumulated in production departments are assigned to individual products or jobs based on predetermined cost driver rates

Stage 2:The costs that have been

accumulated in production departments are assigned to individual products or jobs based on predetermined cost driver rates

The Conventional, Two-Stage Allocation MethodThe Conventional, Two-Stage Allocation Method

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Dekke

r, Ltd.Stage 1: Step 1Stage 1: Step 1

Service Departments

Production Departments $300 $400 $500

$50 $200$100

Total Indirect Costs$1,550

6-15 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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Dekke

r, Ltd.Stage 1: Step 2Stage 1: Step 2

Service Departments

Production Departments $425 $550 $575

$50$50 $200$200$100$100

6-16 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Allocation of Service Department Costs to Production Departments

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Dekke

r, Ltd.Stage 2: Allocation of

Production Department Costs to Jobs and Products

Stage 2: Allocation of Production Department

Costs to Jobs and ProductsProduction Departments-> $425 $550 $575

Job 1

$365 Job 2

$400 Job 3

$525 Job 4

$260

6-17 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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Distortions of Two-Stage Allocations

Distortions of Two-Stage Allocations

Two-Stage Allocation results in distortion of allocated costs because it breaks the link between the cause for overhead costs and the basis for assignment of the costs

Two-Stage Allocation results in distortion of allocated costs because it breaks the link between the cause for overhead costs and the basis for assignment of the costs

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Distortions of Two-Stage Allocations

Distortions of Two-Stage Allocations

Traditional costs systems have not taken into account batch-related and product-sustaining costs when it comes to overhead allocation

Traditional costs systems have not taken into account batch-related and product-sustaining costs when it comes to overhead allocation

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Dekke

r, Ltd.Applying the ConceptsApplying the Concepts

Exercise #1 Identify a cost driver for each of the following activities:

Machine maintenance

Machine setup

Utilities

Quality control

Material ordering

Production scheduling

Factory depreciation

Production supervision

Exercise #1 Identify a cost driver for each of the following activities:

Machine maintenance

Machine setup

Utilities

Quality control

Material ordering

Production scheduling

Factory depreciation

Production supervision

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r, Ltd.Applying the ConceptsApplying the Concepts

Exercise #1 Identify a cost driver for each of the following activities:

Machine maintenance # of machine hours

Machine setup # of setup hours

Utilities # of kilowatt hours

Quality control # of inspections

Material ordering # of orders

Production scheduling # of production runs

Factory depreciation # of square feet

Production supervision Direct labor hours

Exercise #1 Identify a cost driver for each of the following activities:

Machine maintenance # of machine hours

Machine setup # of setup hours

Utilities # of kilowatt hours

Quality control # of inspections

Material ordering # of orders

Production scheduling # of production runs

Factory depreciation # of square feet

Production supervision Direct labor hours

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r, Ltd.Applying the ConceptsApplying the Concepts

Exercise #2

Turn to page 282 and work Exercise 6-22.

Exercise #2

Turn to page 282 and work Exercise 6-22.

16

Activity-Based Costing Systems

Activity-Based Costing Systems

Costing systems based on cost drivers that link activities performed to products and allocate support activity costs directly to products using these cost drivers

Costing systems based on cost drivers that link activities performed to products and allocate support activity costs directly to products using these cost drivers

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Overcome cost distortions resulting from two-stage systems

Use the actual cost driver for each activity to assign costs directly to products

Have changed the way many decision-makers think about management accounting

Overcome cost distortions resulting from two-stage systems

Use the actual cost driver for each activity to assign costs directly to products

Have changed the way many decision-makers think about management accounting

Activity-Based Costing Systems

Activity-Based Costing Systems

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Dekke

r, Ltd.ABC Allocation

ProceduresABC Allocation

ProceduresTrace all overhead costs to activity cost pools

Supervision: Casting

$26,000

Depreciation: Assembly

$9,000

Machine Setup

$300,000

Supervision: Packing

$23,600

6-23 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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r, Ltd.ABC Allocation

ProceduresABC Allocation

ProceduresDetermine Cost Drivers

Supervision: Casting

Casting setup hours

Depreciation: Assembly

Assembly machine-hours

Machine Setup

Total setup hours

Supervision: Packing

Packing direct labor hours

6-24 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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Dekke

r, Ltd.ABC Allocation

ProceduresABC Allocation

Procedures

Determine Normal Level of Cost Driver

Supervision: Casting

500 hours

Depreciation: Assembly

9,000 hours

Machine Setup

300 hours

Supervision: Packing

6,000 hours

6-25 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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Dekke

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ProceduresABC Allocation

Procedures

Determine Cost Driver Rates

Supervision: Packing

$23,600 6,000 hours

Supervision: Casting

$26,000 500 hours

= $52/hour

Depreciation: Assembly

$9,000 9,000 hours

= $1/hour

Machine Setup

$300,000 300 hours

= $1,000/hour= $3.93/hour

6-26 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

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Allocate Costs to Jobs/Products on Basis of Level of Activity

Supervision: Casting

$26,000 500 hours

= $52/hour

Depreciation: Assembly

$9,000 9,000 hours

= $1/hour

Machine Setup

$300,000 300 hours

= $1,000/hour

Supervision: Packing

$23,600 6,000 hours

= $3.93/hour

6-27 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

ABC Allocation ProceduresABC Allocation Procedures

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Exercise #2

Turn to page 283 and work Problem 6-24.

Exercise #2

Turn to page 283 and work Problem 6-24.

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