Chapter 10 - Managing and Allocating Support-Service Costs

CHAPTER 10

Managing and Allocating Support-Service Costs

Chapter Outline

A. Cost Management Challenges — There are three challenges offered in this chapter.

1. Since cost allocation is arbitrary, does it matter how costs are allocated in an
organization?

2. How can a cost allocation approach be chosen that allows proper evaluation of tradeoffs
that may result from the allocations made?

3. How can managers be educated to understand the complexities of the cost allocation
process chosen?

B. Learning Objectives:

1. The chapter explains the importance of managing support service costs and why these
costs are allocated.

2. It provides understanding of the need to choose single or multiple cost pools and to
separate the cost of resources supplied and the cost of resources used.

3. It illustrates how to choose appropriate allocation bases.

4. Chapter 10 illustrates two methods used to allocate support department costs — the direct
and step.

5. The chapter evaluates the consequences of choosing among the cost allocation methods.

6. Reciprocal method of cost allocation is explained in the Appendix.

C. Service cost challenges exist in virtually every type of organization. Organizations exist for a
variety of purposes. For-profit organizations exist to provide goods and services that generate
profit. Non-profit organizations and government units operate to provide goods and services that
benefit members of a community or society at large.

Most of the focus on use of resources in organizations is properly placed on the resources used to
meet the objectives of the organization. However, resources are also used to support productive
processes. Employees provide services such as Human Resources, information systems,
accounting, janitorial services, and top executives’ expertise. Additional resources are expended
to house and equip these services.

Historically, support services have been viewed as relatively minor costs compared to costs of
productive activity. As these costs have increased though, organizations have shifted some of the
cost management focus to controlling, reducing, and minimizing costs of support services.

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1. Support services may be outsourced. Some organizations have chosen to focus

exclusively on their core business. These organizations have consciously chosen to
eliminate in-house performance of support activities. When making a decision to
outsource or not, there are several factors that should be considered.

a. The knowledge base that outsourcing service providers need must be considered.
If the skills or expertise needed to successfully perform services cannot be
obtained outside of an organization, they must be completed internally. On the
other hand, there are some activities that an organization may not have the skills
or expertise to perform. For instance, an organization that is expanding into the
global market may not have in-house expertise in dealing with complex customs
and trade laws or international tax issues. In these instances, it may be more
practical to obtain such expertise from outside sources.

b. Some information or certain activities may be too sensitive to outsource. In this

case, an organization must retain control of these support-service activities by
providing them internally.

c. The costs of outsourcing compared to the cost of performing services internally

must also be considered.

d. The reliability of outside service providers must also be considered. This is

particularly important if outsourced activities are associated in some way with
the reputation of the organization.

D. For those support services that continue to be performed internally, the costs of these services
must be managed. There are several options for managing support-service costs. Two opposing
views are to either provide the services to internal customers at no charge, or to charge internal
customers for support services. Each is discussed below.

1. Internal customers who receive support services might be charged nothing for the
services. In that case, support service costs are recovered from revenues generated from
sale of product (or as illustrated in the text, by tax revenues). Users of the support
services do not have the financial information that helps them to recognize the costs of
using support services. While this approach is simple, it does nothing to encourage
efficient, cost-effective use of the services offered.

2. The costs of support services can be charged to using departments, and costs can be
recovered from these internal customers. This is accomplished by use of a system of cost
allocations. Since support services cannot be directly traced to users, allocation is the
only way that support department costs can be assigned.

Allocation of support department costs is arbitrary and may not be accurate measures of
resource use. Assigning costs may also create tension and dissension internally if
managers do not agree with the charges to their department for the use of support
department services.

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E. Support services exist to facilitate direct or production activities. Direct activities may also be
referred to as line activities. Direct services or production activities exist to meet the objectives of
an organization. Support services exist only to help the entire organization to function more
smoothly.
1. Direct or production departments are those departments that generate revenue. Even in
the case of non-profit organizations or government agencies, certain departments are the
source of cash inflow and can be viewed as direct departments. Support-service
departments, on the other hand, only generate costs.

a. Support-service costs are often facility-level resource costs that don’t vary
directly with production activity.

2. The use of support department costs is not easily observable. For instance, unit-level
production costs are directly related to production activity, and changes in production
costs can be traced to changes in unit-level activity. Support department costs cannot be
traced this way, even though costs may be indirectly related to unit-level production
activities.

For instance, support services of the Payroll Department are necessary because of
employees in direct and other departments. In other words, without the production
activities, there would be no need for a Payroll Department. However, since Payroll
Department employees are paid a salary that is not based purely on production activities,
there is no direct way to trace Payroll Department activities to different production
departments. Even if Payroll Department costs could justifiably be assigned based on
number of employees in each production department, they would not be directly traceable
to units of product unless labor costs themselves could be traced that way.

F. Allocation of support service costs is really a full cost problem, similar to the problems described
in Chapter 4. Recall, in Chapter 4, the problem of assigning higher-level production costs to
lower-level activities made cost allocation necessary. Allocation of support-services costs creates
the same type of problem, because non-production facility-level costs are allocated to production
departments.

1. The impact of cost allocation on managers’ decision-making activities must be

considered. Cost allocation from support departments should be excluded from
consideration in making certain decisions. For instance, decisions about profitability of
products or product lines should not include support department cost allocations.

a. Cost allocations from support departments should be used to highlight the fact
that direct departments are the reason for support department costs. The cost-
causing direct department should pay for support department costs. In order for
them to pay though, there must be a way to determine the amounts due.

b. Allocation of costs to direct (production) departments makes the cost-causers

conscious of the need to manage these costs. If there is no cost attached to
support services, then users may not be efficient in their use of such services.

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c. Allocation of costs aids managers in planning and budgeting. To the extent that
support department costs change with direct department activity, managers can
better anticipate these changes in support department costs. For example, if a
production department anticipates that a large number of new hires will be
necessary in the coming year, it should also be conscious of the attendant costs
that will occur in the Human Resources Department.

2. In addition to managing support-service needs of internal customers, there may be other

reasons for allocating support department costs.

a. Some organizations may be required to report allocations to government

agencies.

b. Cost-plus contracts, which are often used by government agencies, nonprofit

organizations, and academic institutions, make support department allocations
critical to recovery of the entire cost of providing products and services to
external customers.

c. Allocation of facility-level support service costs, like the salaries of top

executives, motivates managers at lower levels to increase profits needed to
cover these higher-level costs.

3. Once the decision to allocate support-service costs is made, a system for allocating these
costs must be chosen and implemented.

G. The choice of methods for cost allocation from support departments to internal customers should
accomplish several objectives. A key objective is to allocate costs in a way that motivates using
departments to use support services wisely. A second objective is to choose an allocation
procedure that is fair and does not cause internal disputes. A third objective is to help managers of
an organization know what amounts of support services are necessary. A fourth objective is to
assure that the costs of the allocation system do not outweigh the benefits.

There are four steps to use that aid in the degree of success achieved in meeting these objectives.
These steps are explained in detail below.

H. Step 1. Costs of support-services must be identified, and decisions must be made regarding how
or if various support-service activities should be combined (pooled).

1. Support service spending must be identified. Identifying support department costs

depends on how and at what level support departments acquire resources. The use of
resources may also differ by level (i.e., facility- or lower-level). Some support department
costs can be traced to direct departments. More often, however, support-service costs
cannot be traced, and must be allocated.

a. Support-service costs can be identified and pooled based on resource type. For
instance, human resource costs could be separated from equipment and space
costs for a given support department, or one type of support department may be
separated from another type of support department.

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2. Support service uses must be identified. Organizations may identify and then pool costs
based on uses of facility-level support-service resources. This is especially useful when a
support department has both facility-level and lower-level components.

a. Managers need to be cognizant of the costs associated with having many cost
pools. At the same time, expanding the number of cost pools will increase the
accuracy of cost allocations. There is a tradeoff between controlling the costs of
having an accurate allocation system and limiting the degree of accuracy the
system can provide.
b. Often, organizations may have support-service department pools for each
department, or for each function, or for broad categories of functions.

3. Costs to be allocated must be measured. Allocation of support department costs cannot be

based on the actual costs, because they are not known early enough to allocate them. This
makes it necessary to develop estimates of support-service costs.

4. Cost of resources supplied must be separated from cost of resources used. For example,
you may have five guards in facilities even though three of them are essentially needed
for now. Users should be charged for the cost of resources used and not with the total
cost of resources supplied.

I. Step 2. Choose the appropriate cost allocation bases and calculate rates. Once the costs and cost
pools are identified, an allocation base must be chosen and allocation rates, or amounts to
allocate, must be calculated. The allocation base should mirror, as closely as is practical, a cost-
driver base. This means that the base should be indicative of a causal link between the cost and
the cost allocation. Such a link improves the planning and decision-making activities of
managers. It may also influence behavior if managers see that their actions affect support-service
costs.

1. An activities-based cost approach can be used to assign support department costs. This
entails the following.

a. Measure each support department’s resource spending (costs) by level. This

means that unit, batch, product, customer, and facility-level costs must be
identified.

b. Identify and measure activities demanded by internal customers that require

support-service spending. This allows cost-driver bases to be chosen.

c. Derive cost-driver rates by dividing costs by the activity.

2. A cost allocation approach that is more traditional than ABC is used by many
organizations. Traditional cost allocations often use allocation bases such as number of
employees, space occupied, hours of use, or other activities that are more general than
those used in an ABC system.

a. If allocation bases are not cost drivers, they must at a minimum be justifiable for
use as an allocation base.

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J. Step 3. A cost allocation method must be selected and implemented. Two commonly used
methods are the direct method and the step method. A third method, the reciprocal method, is not
widely used and is presented in the appendix to Chapter 10. The direct and step methods are
described below.

1. The direct method of cost allocation charges support department costs only to internal
customers in direct (production) departments. This allocation method ignores the use of
support services between support service departments. The direct method places
emphasis on the fact that, ultimately, all support-service costs are paid for by production
departments.

a. Suppose that an organization has two support departments, S1 and S2, and it has
two production departments, P1 and P2. Costs of department S1 would be
allocated to departments P1 and P2. Costs of department S2 would be allocated
to departments P1 and P2. With the direct method, no costs of department S1
would be allocated to department S2, and no S2 costs would be allocated to
department S1.

b. The chief criticism of the direct method is that it ignores the use of support
departments by other support departments. For instance, the Accounting
Department hires new employees and therefore uses the services of the Human
Resources Department. Human Resources uses the Accounting Department
whenever it needs to have a bill paid. Neither of these support departments
receives a cost allocation from the other support department. This is justifiable
for two reasons. First, support department costs are fairly small relative to
production department costs, so the degree of accuracy needed in assigning
support department costs to other support departments need not be extensive.
Second, since all support department costs are ultimately allocated to production
departments anyway, an interim allocation between support departments is
viewed by some as an unnecessary complication.

2. The step method partially addresses the criticisms leveled against the direct method. The
step method allocates costs from the support department with the largest proportion of its
total allocation base in other support departments to other support and production
departments. This first support department is the most general support department. Then
costs from the second most general support department are allocated to the remaining
support departments and all of the production departments. The support department with
the smallest proportion of its costs in other support departments has its costs allocated
only to production departments.

a. Once a support department’s costs are allocated, nothing is ever allocated back to
it, even though it may use the services of the remaining support departments.
Thus, allocations from support departments are made in only one direction.

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b. Using the example presented in the discussion of the direct method, suppose
there are two support departments, S1 and S2, and two production departments,
P1 and P2. If department S1 is the most general support department, then its costs
will be allocated to departments S2, P1, and P2. Department S2 would then have
its own costs plus the allocated amount it received from department S1. Then
department S2’s adjusted cost would be allocated to production departments P1
and P2.

c. The step method is viewed as an improvement over the direct method, because it
partially recognizes the reciprocal relationships among support departments.
Many companies opt for the direct method because it is easier to use and
maintain, particularly if interdepartmental services are insignificant.

d. When using step allocation, one must allocate the service department with the
largest percentage of service provided to other service departments first, before
proceeding to the second department and so forth.

3. Critics of the step method argue that, if a more complex method is to be used, it should be
the reciprocal method. The reciprocal method assigns costs of every support department
to every other department that uses it. Thus, if department S1 uses department S2, and
department S2 uses department S1, then each support department will receive an
allocation from the other support department. The main criticism of the reciprocal
method is that it unnecessarily complicates the cost allocation process, particularly since
all of the support department costs end up being allocated to the production departments
anyway.

K. Step 4. Evaluation of the choices among allocation methods should reveal whether the desired
results will be achieved by the allocation method chosen. The desired results include accuracy,
effects on departments, and linkage between costs and benefits.

1. The allocation process cannot be perfectly accurate. Since cost allocations are always
arbitrary to some extent, managers must balance their degree of tolerance for the
inaccuracy against their degree of tolerance for costs of having a more expensive
allocation method. It may not be cost-effective to modify allocation of support
department costs to improve accuracy.

2. Another way to evaluate cost-allocation methods is to look at the effects of alternative

methods on production departments. If costs are allocated to managers of production
departments, managers will be resistant to any allocation method that increases support
department costs to their department.

a. One factor that should influence the choice of methods — ABC, reciprocal, step,
or direct — is the amount of support services used by other support departments.
If the amount of use is high between support departments, use of the direct
method will distort the true costs of support services used by the various
production departments.

b. If support department costs are used to evaluate managers, then managers will
prefer whichever cost allocation method assigns the least cost to them, but this
should not be a real concern of cost managers.

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c. All support department allocation methods are assigning the same amount of
total cost to production departments. However, the method chosen can change the
amount of cost allocated to individual departments. An undesirable result of
assigning support department costs to a production department is that the
manager of the production department may cut back on the use of the support
departments’ services just to reduce his or her departments’ costs. While this may
have the desired effect in that production department, it simply means that the
cost will be reassigned to another department in the short run. In the long run,
costs and services would be reduced, and that manager would have access to
lower levels of service.

Suppose a trucking company revised its cost allocations in such a way that
resulted in truck maintenance costs (a support service) being allocated differently.
If the allocation base is mechanic hours, then the manager of a truck facility
would be tempted to reduce mechanics’ time to reduce maintenance costs. This is
certainly not a desired effect of cost allocation.

d. The choice of allocation method could affect amounts allocated in cost-plus

contracts. If an organization has a mix of external customers, some with cost-plus
contracts, and others with market-based contracts, the tendency would be to
allocate as much support department cost to the cost-plus contracts. Customers
with such contracts need to recognize this tendency and must insist on knowing
how costs are determined and assigned. Many federal government contracts are
cost-plus, and contractors are given very specific limits on allocation methods
and amounts.

3. A third consideration in evaluating which cost allocation method to choose is the relation
between costs and benefits of setting up, administering, and maintaining the system.
Complex systems are much more difficult to maintain than simple systems. Each year,
allocation bases and cost estimates change. New rates must be calculated for every cost
base used. Organizational structure also changes, making it necessary to revise estimates
of the use of support department services.

a. At times it is necessary to fine-tune an allocation system, especially if it is

causing undesirable results.

b. Ethical considerations may lead to challenges in how cost allocations are made,
especially in cost-plus contracts, or when government agencies charge taxes
based on cost-plus estimates of taxes charged.

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L. Reciprocal method of cost allocation allows for interdepartmental (reciprocal) use of services.
For example, if personnel department uses services of payroll department, and payroll department
receives services of personnel department, there should theoretically be a recognition of this
reciprocal service; i.e., each department should be charged with a fair share of the other
department’s costs. A mathematical model can be established to allow for accounting of such
interdepartmental services. Software packages may be utilized for such accounting. Essentially,
we need set up reciprocal equations.
Total departmental costs (P) = Direct cost of the dept.($) + service costs to be allocated to the
dept. (S). Assume S1 = 86,000 + .20 S2 while S2 = 30,000 + .40 S1. We can continue with
these equations as follows:
S1 = 86,000 + .20 (30,000 + .40 S1)
S1 = 86,000 + 6,000 - .08 S1
S1 - .08 S1 = 92,000
.92S1 = 92,000 / .92
S1 = 100,000.
Now that we have S1, we can solve for S2.
S2 = 30,000 + (.40 * 100,000)
S2 = 70,000.

Problem 1 – Chapter 10
Cost allocation and management decisions
LO: 1 and 4
Time required: 45 minutes

Saba Electronics has two service departments computer services (S1) and personnel (S2) as well as two
production departments (P1 and P2). S1 costs amount to $285,000 and S2 costs amount to $98,500.
Direct overhead of production departments amount to $495,000 and $386,500 respectively. S1
department is equipped to provide a total of 600 CPU hours of service. Currently, however, S2 uses 100
hours, P1 150 hours and P2 200 hours of this service. S2’s costs are allocated to production units based
on number of employees. P1 has 120 and P2 has 280 employees. P2 has indicated that due to the
exorbitant costs of S1, it will contract out 100 hours of its work to an outside contractor which charges
$350 for one hour of CPU time.
Required:
1) Using step-down allocation, allocate costs assuming that all resources provided are charged to the
end units.
2) Using step-down allocation, allocate costs assuming that only resources used are charged to the
end units.
3) Using step-down allocation, allocate costs assuming that P2 contracts out 100 hours of its work as
indicated in the problem. Charging is based on resources used by departments.
4) Discuss the alternatives and various implications of cost management for the computer services
department.

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Solution:
1) S1 S2 P1 P2
Direct cost 285,000 98,500 495,000 386,500
S1 allocated (CPU hours) 450 100 150 200
S1 allocated $'s 285,000 63,333 95,000 126,667
S2 allocated (No of employees) 120 280
161,833 48,550 113,283
Costs after allocation 638,550 626,450
2) S1 S2 P1 P2 Unused
Direct cost 285,000 98,500 495,000 386,500
S1 allocated (CPU hours) 600 100 150 200 150
S1 allocated $'s 285,000 47,500 71,250 95,000 71,250
S2 allocated (No of employees) 120 280
146,000 43,800 102,200
Costs after allocation 610,050 583,700
3) S1 S2 P1 P2
Direct cost 285,000 98,500 495,000 386,500
S1 allocated (CPU hours) 600 100 150 100 250
S1 allocated $'s 285,000 47,500 71,250 47,500 118,750
S2 allocated (No of employees) 120 280
146,000 43,800 102,200
Costs after allocation 610,050 536,200

5) It appears that computer department has considerable excess capacity. If the cost is not charged
to the final using departments, it would be absorbed as a loss. Furthermore, based on P2’s
decision, it appears that computer cost per hour is significantly higher than what outsiders can
provide for this type of service. Management should ask some hard questions. Can S1 ever
become competitive? Can the excess capacity either be reduced or the excess capacity utilized or
rented out?

In the long-run, S1 has to become competitive. Otherwise, the service should be outsourced. In
the short-run, management should see whether partial outsourcing of P2 would reduce S1 costs at
least by the amount paid out by P2 for outsourcing. Otherwise, it would be advantageous for the
company to continue the service internally while looking for long-term solutions. P2 may be
compensated by the higher management for the amount that it is sacrificing for buying the service
internally.

Problem 2
LO: 1, 2, 3
Managing service department costs and finding appropriate allocation bases:
Estimated time: 20 minutes

Omid Printing had three service departments; Graphic Design, Personnel, and Accounting. The
producing departments for the firm were copying and printing. Other data regarding these departments
follow:

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Item Graphic Design Personnel Accounting Copying Printing

Design Effort 20% 80%
Number of 5 7 10 25 70
employees
Accounting 4% 6% 10% 80%
effort
Direct cost $200,000 $140,000 300,000 $600,000 $1,400,000
Allocation DL hours Machine Hrs.

Omid has assigned you to determine a cost allocation method for the company. Discuss a) the pros and
cons of each method, b) the pros and cons of no allocation charge, c) the sequence that the service
departments need to be allocated and the reasoning behind it, d) what allocation bases you use for each
cost pool and why.

Answer:
a) Direct method is the easiest but the least accurate. Reciprocal method is most accurate but the
most complicated. Step allocation method falls in between the two.
b) If no allocation is made to the final users, the producing department will not understand or be
concerned about the cost of service departments and their use and request of services from those
departments may be unreasonable and unrealistic. In addition, the cost related to each
manufacturing department will not be properly identified, and there will be no way that one can
come up with a reasonable costing method for the organization.
c) Generally, the department that provides the most service to other service departments and has the
highest cost should be allocated first (in case of step method of cost allocation) to come up with
the most reasonable answer. It does not make any difference in case of the other two methods of
cost allocation. Accordingly, in this problem, Accounting needs to be allocated first (highest cost
and provides the most service), followed with Personnel (because Personnel provides service to
Graphic Design, but Graphic Design does not provide service to Personnel.
d) As illustrated in the above Table, the Accounting Manager and Graphic Design may estimate
based on experience the amount of time needed for servicing each department. Personnel cost
may be allocated based on some more objective basis such as number of employees.

Problem 3.
General
Dual Allocation
Estimated time: 15 minutes

Consider the budget and actual cost of computer services for Saba Company:
Item Budget Actual
Supervision $4,800,000 $4,650,000
Data Entry 3,200,000 3,900,000
Computer Lease 6,200,000 6,078,000
Supplies 420,000 785,000

Production Division A’s share of the above service 30% 20%

Production Division B’s share of the above service 70% 80%

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Required: What would be the most logical way of allocating the computer department costs to
division A and B? Try to be analytical as well as logical in coming up with an innovative and useful
method of cost allocation in this particular case.

Answer:
The most logical system of cost allocation in this case is a dual allocation method where actual fixed
costs would be allocated based on budgeted percentages – because the department commits capacity
utilization based on production managers’ estimated need of those services, and actual variable costs
would be allocated based actual usage of those services (such as the amount of printing paper
needed), based on actual usage of those services regardless of what the budgeted percentages were.
Alternatively, one could use budgeted fixed costs and budgeted percentages for fixed cost portion,
and budgeted rate for variable costs and actual volume of services used for variable costs. In this
situation, inefficiencies of the service department will not be transferred to the final using
departments, and managers remain accountable for services provided and services used based on
agreed upon rates. This approach makes performance evaluation more feasible and meaningful with
variances charged directly to some loss account rather than being transferred to the final users of
those services. This is like having concluded an agreement with an outside firm (like outsourcing),
and the producing departments knowing ahead of time the rates for which they will be charged for the
services that they request from such outside sources.

Problem 4.
Omid Manufacturing has two service departments (Personnel and Maintenance) and two
manufacturing departments (M1 and M2). Personnel is allocated based on number of
employees. Maintenance based on service hours provided. M1 is finally allocated based on
machine hours and M2 is allocated based on direct labor hours. The outputs of the firm are
products A and B. A uses $145 of material, $22 of labor, 1.2 machine hours in M1 and 2.8 hours
of labor hours in M2. Other information follows:
Item Personnel Maintenance Manufacturing 1 Manufacturing 2
Number of employees 5 25 30 70
Maintenance hours 100 200 600 1900
Direct overhead $32,000 $68,000 $494,880 $981,920
Machine hours 2,400 1,600
Labor hours 3,200 8,800

Required:
a) Use direct allocation to close service department costs, determine the overhead rates in M1 and
M2, and compute the final cost of product A.
b) Use step allocation to close service departments with Maintenance to be allocated first, determine
the overhead rates in P1 and P2, and compute the final cost of product A.
c) Use reciprocal allocation to close service departments, determine the overhead rates in M1 and
M2, and compute the final cost of product A.
Solution: a)

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Cost of Product A:
145+22+(1.2*217)+(2.8*120) = $763.40

b)

The difference in cost using direct or step method is quite minimal as you see from the above
worksheets. Accordingly, direct allocation of costs would have been adequate.

c) Reciprocal allocation
S1: 32,000 + (100/2600) S2
S2: 68,000 + (25/125) S1
Solving for S1 results in $34,883.71
Solving for S2 results in $74,976.57

The same logic applies here. The difference between direct, step, and reciprocal methods used is
minimal. Therefore, using direct method for cost allocation must be adequate.

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Sample Quiz

1. The reason(s) stated for cost allocation often include

a. the requirements for tax regulations and financial accounting.
b. determination of the fair value of cost-plus contracts for reimbursement purposes.
c. influencing management’s behavior in cost control.
d. choosing a basis even though it may appear somewhat arbitrary.
e. all of the above

Answer: e Learning Objective: 1

2. Support services to be allocated

a. use only one allocation base in each department.
b. may use several allocation bases for each pool of costs.
c. could charge some departments for specialized services without allocation.
d. b and c
e. a and c

Answer: d Learning Objective: 1

3. A reasonable allocation base for heating and air conditioning costs may be
a. quantity of material used.
b. volume occupied.
c. space occupied.
d. number of documents.
e. None of the above.

Answer: b Learning Objective: 2

Use the following data to respond to questions 4 through 15.

Omid Printing has two service departments (S1 and S2) and two manufacturing departments (M1 and
M2). S1 is allocated based on number of employees. S2 is allocated based on maintenance hours. The
company produces two products (P1 and P2). P1 uses $167 of labor and material. It uses 1.2 machine
hours in M1 and 2.8 labor hours in M2. P2 has the same labor and material cost but uses 3.2 machine
hours in M1 and 1.6 labor hours in M2.
Other data follows:

Item S1 S2 M1 M2
Number of employees 15 25 30 70
Maintenance hours 100 200 600 1900
Direct overhead $32,000 $68,000 $495,000 $984,000
Machine hours 2400
Direct labor hours 8800

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4. Using direct allocation, S1 charge to M1 amounts to

a. $9,600
b. $22,400
c. $16,320
d. $51,680
e. None of the above.

Answer: a Learning Objective: 4

5. Using direct allocation, S2 charge to M1 amounts to

a. $9,600
b. $22,400
c. $16,320
d. $51,680
e. None of the above.

Answer: c Learning Objective: 4

6. Using direct allocation, M1’s overhead rate per hour amounts to

a. $217.05
b. $157.05
c. $120.24
d. $102.24
e. None of the above.

Answer: a Learning Objective: 4

7. Using direct allocation, P1’s product cost per unit (rounded) amounts to
a. $597
b. $764
c. $889
d. $1,056
e. None of the above.

Answer: b Learning Objective: 4

8. Using direct allocation, P2’s share of overhead per unit (rounded) amounts to
a. $597
b. $764
c. $889
d. $1,056
e. None of the above.

Answer: c Learning Objective: 4

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Chapter 10 - Managing and Allocating Support-Service Costs

9. If step-allocation method is used,

a. S1 should be allocated first because it provides more service to S2.
b. S2 must be allocated first because it provides more service to S1.
c. S1 should be allocated first because it is the order that the problem assumes.
d. S2 should be allocated first because it has a higher total amount than S1.
e. None of the above.

Answer: b Learning Objective: 4

10. Using step allocation and assuming that S2 is allocated first, M1 share of S2 (rounded) amounts to
a. $10,383
b. $15,694
c. $24,228
d. $49,694
e. None of the above.

Answer: b Learning Objective: 4

11. Using step allocation and assuming that S2 is allocated first, M1 share of S1 (rounded) amounts to
a. $10,383
b. $15,694
c. $24,228
d. $49,694
e. None of the above.

Answer: a Learning Objective: 4

12. Using step allocation and allocating S2 first, overhead rate per hour for M2 amounts to
a. $110.22
b. $120.22
c. $207.12
d. $217.12
e. None of the above.

Answer: b Learning Objective: 4

13. Using step allocation and allocating S2 first, cost per unit of P2 (rounded) amounts to
a. $764
b. $864
c. $954
d. $1,054
e. None of the above.

Answer: d Learning Objective: 4

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Chapter 10 - Managing and Allocating Support-Service Costs

14. If reciprocal allocation is used,

a. S1 should be allocated first because it is so listed in the problem.
b. S2 should be allocated first because it provides more service to S1.
c. S2 should be allocated first because it provides more service to P1.
d. S2 should be allocated first because it provides more service to P2.
e. Order of allocation does not make any difference.

Answer: e Learning Objective: 6

15. Using reciprocal allocation, amount charged by S1 to S2 (rounded) amounts to

a. $2,611
b. $2,790
c. $3,538
d. $4,538
e. None of the above.

Answer: d Learning Objective: 6

16. Comparing direct allocation to reciprocal allocation, total costs after allocation
a. tend to be higher using the first method.
b. tend to be higher using the second method.
c. are the same regardless of the method used.
d. tend to be slightly different depending on the method used.
e. none of the above.

Answer: c Learning Objective: 6

17. Comparing step allocation to reciprocal allocation, total cost of service departments after allocation to
other service departments is
a. same as the costs before allocation.
b. higher when reciprocal method is used.
c. lower when reciprocal method is used.
d. tends to be slightly different depending on the method used.
e. None of the above.

Answer: b Learning Objective: 6

18. Cost allocation has implications in

a. managerial decisions.
b. product or service costs.
c. company income level from period to period.
d. contractual compliance.
e. all of the above.

Answer: e Learning Objective: 5

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Chapter 10 - Managing and Allocating Support-Service Costs

19. Which of the following methods do NOT charge service department costs to a service department
after its costs have been allocated?
a. the step-down and reciprocal
b. the direct and step-down
c. the reciprocal and direct method
d. he simultaneous equation method
e. algebraic matrix method

Answer: b Learning Objective: 5

20. The reciprocal cost allocation method begins with allocation of the costs of the service department
that
a. provides the greatest percentage of service to the production departments.
b. provides the greatest percentage of its service to other service departments.
c. has the total highest cost among the service departments.
d. has the combination highest percentage and dollar amount of its service to other service
departments.
e. None of the above.

Answer: d Learning Objective: 6

21. Computer dept. costs are allocated based on CPU time used. CPU time used by Personnel is 600
minutes, by machining 3,400 minutes, and by assembly 2,000 minutes. Total computer dept. cost
amounts to $84,000. Personnel dept. costs are allocated based on number of employees. Its total cost
amounts to $48,000. Computer dept. has 200 employees, machining 500, and assembly 300. What is
Computer dept. cost using reciprocal method?
a. $84,000
b. $86,612
c. $90,612
d. none of the above

Answer: c LO: 6
C = 84,000 + .10 P; P = 48,000 + .20 C; therefore, C = 84,000 + .10 (48,000 + .20C); solving for C,
We get $90,612.

22. Computer dept. costs are allocated based on CPU time used. CPU time used by Personnel is 600
minutes, by machining 3,400 minutes, and by assembly 2,000 minutes. Total computer dept. cost
amounts to $84,000. Personnel dept. costs are allocated based on number of employees. Its total cost
amounts to $48,000. Maintenance has 200 employees, machining 500, and assembly 300. What is
Personnel dept. cost using reciprocal method?
a. $48,000
b. $56,122
c. $66,122
d. $76,000

Answer: c LO: 6
C = 84,000 + .10 P; P = 48,000 + .20 C; therefore, C = 84,000 + .10 (48,000 + .20C); solving for C,
We get $90,612. We can now use the cost obtained in the Personnel dept. equation:
P = 48,000 + (.20 * 90,612) = $66,122.

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