You are working in accounting department of Frank Compagny. You will allocate th
ID: 2578832 • Letter: Y
Question
You are working in accounting department of Frank Compagny.
You will allocate the support department costs to operating departments using Direct Method. You have also to explain the details of calculations to Mr Ibrahim who is a student having training in Frank company (you will explain the formulas used in the calculations to Mr Ibrahim).
The information for the current period is as follows:
Support Departments
Operating Departments
Medical
Allocation Bases:
Support Departments
Operating Departments
Medical
No. of Employees
Square Feet
Administration Cost will be allocated using number of employees and Housekeeping cost will be allocated using square feet.
Explain to Mr Ibrahim the objectives of allocation of support department costs.
Discuss with Mr Ibrahim why you are using the direct method. What are the other possible methods? What is the difference between these methods and when we will have to use each method?
Support Departments
Operating Departments
Administration HouskeepingMedical
Dintal Total cost 32,400 50,000 130,000 180,000 310,000Explanation / Answer
Calculations:
Explanation of calculations: Under the Direct method of cost allocation, the support department costs are directly allocated to the operating departments in the proportion of their respective cost allocation bases. Thus, the administration department costs are allocated to the two operating departments based on the number of employees in each department. Hence administration costs allocated to Medical department are $32400 x 6 / (6 + 2) = $24300 and those allocated to the Dental department are $32400 x 2 / (6 + 2) = $8100. Similarly, using the square feet occupied as the basis for the allocation of the housekeeping department costs, the medical departments share would be $50000 x 6000 / (6000 + 4000) = $30000 and that of the dental department would be $50000 x 4000 / (6000 + 4000) = $20000.
Objectives of allocation of support department costs: The services of the support departments are utilized by the operating departments. Costs of support departments are therefore common costs that need to be allocated to the operating departments to arrive at the operating department's correct profitability. It also thus encourages the operating departements to use the services of the support departments judiciously so as to keep their own costs down.
Reasons for using the Direct method: The direct method of cost allocation is the simplest of the three allocation methods as it directly allocates the costs to the operating department without allocating to other support departments. It is thus less cumbersome as calculations required are also simple.
Other methods: Besides the direct method which has been used and discussed above, the other two methods of cost allocation are the step method and the reciprocal method. Under the step method, the support department costs are allocated in a sequence to the other support departments and the operating departments. When one support departments costs are allocated, no further costs get allocated back to it. Thus, the subsequent support departments in the sequence will have their own direct costs and the costs allocated to them from the earlier support department. Under the reciprocal method, unlike the step method, there is lot of back and forth allocations as every support department's costs are allocated to all the other support departments and the operating departments. Several linear equations are used for allocating costs under this method and it is the most tedious method of cost allocation. The step and reciprocal methods lead to more accurate allocations than the direct method and are used when a support department services are also used by the other support departments along with the operating departments.
Support Departments Operating Departments Total Administration Housekeeping Medical Dental Departmental costs before allocations 32400 50000 130000 180000 392400 Allocations: Administration -32400 24300 8100 0 Housekeeping -50000 30000 20000 0 Total costs after allocation $ 0 0 184300 208100 392400Related Questions
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