Chapter 4B Notes Page 1 Please Send Comments and Corrections to me at [email protected] Support Departments This Appendix continues our discussion of different methods that companies use to allocate their Manufacturing Overhead to their products or services. We have already discussed dividing a firm’s operations by Production Departments (also known as Operating or Producing Departments), and using Departmental Application Rates. A refinement to that approach is to include Support Departments (also known as Service Departments) in this division. By dividing its Manufacturing Overhead into multiple Support and Production Departments, a company is attempting to better match its overhead to the products that generated it. When the departments are labeled “cost centers,” then Support Departments are referred to as Intermediate Cost Centers and Producing Departments are referred to as Final Cost Centers. In a manufacturing context, Production Departments are the departments that actually produce the product being manufactured (e.g., assembly department, mixing department, bottling department, and/or packaging department). In service industries, Production Departments deliver services directly to their clients (e.g., an accounting firm’s auditing department, tax department, and/or consulting department). Support Departments do not actually produce the products or services provided to customers. Instead, they provide support services (e.g., security department, maintenance department, word processing department, legal department, and/or computer service department) that help the Production Departments to provide the products or services to their customers. Manufacturing Overhead that cannot be identified with a department is placed in a “general overhead” department. Support Departments are part of the Manufacturing Overhead of the factory, and their cost represents part of the overhead of the Production Departments. The cost of the Support Departments will be allocated to the Production Departments. When the Production Departments receive the allocated Support Departments costs, these costs: (i) become part of the overhead cost of the Production Departments, and (ii) are allocated to the goods or services produced by the Production Departments along with the other overhead costs of the Production Departments. Each Support Department should choose the Cost Driver that gives the most accurate reflection of how its services are consumed. They are free to use different Cost Drivers. Support DepartmentChapter 4B Notes Page 2 Please Send Comments and Corrections to me at [email protected] Example Consider the Firm, a prominent Memphis law firm. The Firm divides its lawyers into two Production Departments: (i) the Corporate Department, and (ii) the Litigation Department. The Firm also has Support Departments. One of those Support Departments, the Word Processing Department, provides word processing services to the Corporate and Litigation Departments: The $200,000 cost of the Word Processing Department is really part of the overhead cost of the Corporate Department and the Litigation Department. If you allocate the cost of the Word Processing Department based upon the hours worked for each department (Cost Driver), then the Corporate Department will be allocated 60% of the cost of the Word Processing Department. Also, the Litigation Department will be allocated 40% of the cost of the Word Processing Department. Interactions Between Support Departments If you have multiple Support Departments that provide services to each other, then you have to consider how to deal with this interaction between the Support Departments. Assume that the Firm has two Support departments (Word Processing and Recruiting):Chapter 4B Notes Page 3 Please Send Comments and Corrections to me at [email protected] A small portion (9.09%) of the $200,000 Word Processing cost is a Recruiting cost, and a small portion (4.76%) of the $200,000 Recruiting cost is a Word Processing cost. If each Support Department gives part of its cost to the other Support Department, then each Support Department would have new costs that need to be allocated to all of the Departments to whom it provides services (including the other Support Department). These allocations would go back and forth between the Support Departments at a diminishing rate because most of the allocated cost would go to the Production Departments. This can be seen in the diagrams appearing below. Companies give varying degrees of recognition to the interaction between Support Departments by using three alternate methods to allocate Support Department costs to the Production Departments: (i) the Direct Method, (ii) the Step-Down Method, and (iii) the Reciprocal Method. A firm selects the method that provides it with an acceptable level of accuracy at an acceptable cost. Direct Method With the Direct Method, you allocate the cost of the Support Departments to the Production Departments without any recognition of the services that the Support Departments provide to each other. Applying the Direct Method to the Firm’s two Support Departments, you would allocate the cost of the Support Departments to the two Production Departments ignoring (i) the 10 hours of work done by Word Processing for Recruiting and (ii) the 5 hours of work done by Recruiting for Word Processing.Chapter 4B Notes Page 4 Please Send Comments and Corrections to me at [email protected] Corporate Litigation Word Processing: $200,000 (60/100 x $200,000) $120,000 (40/100 x $200,000) $80,000 Recruiting: $200,000 (50/100 x $200,000) $100,000 (50/100 x $200,000) $100,000 Allocated Costs: $220,000 $180,000 Note that we allocated all of the cost of the Support Departments ($200,000 + $200,000 = $400,000) to the Production Departments ($220,000 + $180,000 = $400,000). The purpose of each of these three methods is to allocate the aggregate amount of Support Department costs to the Production Departments. If you do not allocate all of the Support Department costs to the Production Departments, then you have made a
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