COMMON COST ALLOCATION

COMMON COSTS OR “OH”

  • SERVICE DEPARTMENT COSTS
  • JOINT COSTS

WHY ALLOCATE?

  • GAAP REQUIREMENT / FAC
  • CORRECT PRICING
  • BIDDING SITUATIONS
  • GOVERNMENT CONTRACTS
  • PROFITABILITY ANALYSIS
  • CONTROL COSTS
  • PREVENT MISUSE OF OH COSTS
  • CLOSER MONITORING OF SERVICE DEPARTMENTS

HOW TO ALLOCATE?

SERVICE DEPARTMENT COSTS
  • DIRECT METHOD
  • STEP-DOWN/SEQUENTIAL METHOD
  • RECIPROCAL METHOD
JOINT COSTS
  • PHYSICAL UNIT METHOD
  • NET REALIZABLE METHOD (NRV)
  • APPROXIMATE NRV METHOD



WORKSHEET: ALLOCATION OF JOINT COSTS

/ PROD. A
300K LBS.
@ $1/LB. / / ADDL. COSTS
$100K / / PROD. C
300K LBS.
@$3/LB.
JOINT COSTS
$500K /
PROD B.
200K LBS.
@$1. 5/LB.

1.PHYSICAL UNIT METHOD

WEIGHT / RATIO / ALLOCATION OF JOINT COSTS
PRODUCT A
PRODUCT B
TOTAL

2.RELATIVE SALES VALUE OR NRV (NET REALIZABLE VALUE) METHOD

SALES VALUE AT SPLIT OFF / RATIO / ALLOCATION OF JOINT COSTS
PRODUCT A
PRODUCT B
TOTAL

3.APPROXIMATE RELATIVE SALES VALUE OR APPROXIMATE NRV METHOD

FINAL SALES VALUE / ADDITIONAL PROCESSING
COSTS / APPROX. NRV / RATIO / ALLOCATION OF JOINT COSTS
PROD A
PROD B
TOTAL

1.PHYSICAL UNIT METHOD

WEIGHT / RATIO / ALLOCATION OF JOINT COSTS
PRODUCT A / 300 / 0.6 / 0.6*500K = $300, 000
PRODUCT B / 200 / 0.4 / 0.4*500K = $200, 000
TOTAL / 500 / 1.0 / $500, 000

2.RELATIVE SALES VALUE OR NRV (NET REALIZABLE VALUE) METHOD

SALES VALUE AT SPLIT OFF / RATIO / ALLOCATION OF JOINT COSTS
PRODUCT A / $300, 000 / 0.5 / 0.5*500K = $250, 000
PRODUCT B / $300, 000 / 0.5 / 0.5*500K = $250, 000
TOTAL / $600, 000 / 1.0 / $500, 000

3.APPROXIMATE RELATIVE SALES VALUE OR APPROXIMATE NRV METHOD

FINAL SALES VALUE / ADDITIONAL PROCESSING
COSTS / APPROX. NRV / RATIO / ALLOCATION OF JOINT COSTS
PROD A / $900, 000 / $100, 000 / $800, 000 / 0.7273 / $363, 636.4
PROD B / $300, 000 / $0 / $300, 000 / 0.2727 / $136, 363.6
TOTAL / $1, 100, 000 / 1.0000 / $500, 000

4. SELL AT SPLIT-OFF OR PROCESS FURTHER

DECISION RULE:

IF {FINAL SALES VALUE – INITIAL SALES VALUE – ADDL. COSTS} > 0,

THEN PROCESS FURTHER; ELSE SELL AT SPLIT-OFF

PRODUCT

/ FINAL
SALES
VALUE (A) / INITIAL
SALES
VALUE (B) / ADDITIONAL
PROCESSING COSTS (C) / INCREMENTAL PROFITS
(A – B – C)
A / 900,000 / 300,000 / 100,000 / 500,000 (*)

* GREATER THAN ZERO, HENCE PROCESS FURTHER

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WORKSHEET: ALLOCATION OF SERVICE DEPARTMENT COSTS

PRODUCTION DEPARTMENTS / SERVICE DEPARTMENTS
CUTTING / / PERSONNEL
(COSTS = $30,000)
ASSEMBLY / / MAINTENANCE
(COSTS = $70,000)
CUTTING / ASSEMBLY / PERSONNEL / MAINTENANCE
# EMPLOYEES / 120 / 60 / 10 / 30
SQUARE FEET / 8,000 / 10,000 / 2,000 / 1,000

1.DIRECT METHOD

CUTTING / ASSEMBLY / TOTAL
MAINTENANCE COSTS
ALLOCATION BASE
ALLOCATION RATIO
COSTS ALLOCATED
PERSONNEL COSTS
ALLOCATION BASE
ALLOCATION RATIO
COSTS ALLOCATED
TOTAL ALLOCATION

DIRECT METHOD

CUTTING / ASSEMBLY / TOTAL

MAINTENANCE=$70K

ALLOCATION BASE
ALLOCATION RATIO
ALLOCATION / 8,000 SQR FT
8,000/18,000 = 44.4%
0.444*70,000=$31,080 / 10,000 SQR FT
10,000/18,000 = 55.6%
0.556*70,000=$38,920 / 18,000 SQR FT
100%
$70,000

PERSONNEL=$30K

ALLOCATION BASE
ALLOCATION RATIO
ALLOCATION / 120 EMPLOYEES
120/180 = 66.7%
0.667*30,000=$20,000 / 60 EMPLOYEES
60/180 = 33.3%
0.333*30,000=$10,000 / 180 EMPLOYEES
100%
$30,000

TOTAL

/ $51,080 / $48,920 / $100,000
2. STEP-DOWN / SEQUENTIAL METHOD
  • ARRANGE SERVICE DEPARMENTS STARTING WITH LARGEST COST TO LOWEST COST
  • ARRANGE PRODUCTION DEPARTMENT IN ANY ORDER
  • ALLOCATE SERVICE DEPARTMENT COSTS SEQUENTIALLY DROPPING ONE SERVICE DEPARTMENT AT EACH STEP
  • WHILE ALLOCATING A SERVICE DEPARTMENT’S COSTS, ADD ALL PREVIOUSLY ALLOCATED COSTS
  • STOP WHEN YOU HAVE ONLY THE PRODUCTION DEPARTMENTS

2.STEP-DOWN OR SEQUENTIAL METHOD

PERSONNEL / CUTTING / ASSEMBLY / TOTAL
MAINTENANCE COSTS
ALLOCATION BASE
ALLOCATION RATIO
COSTS ALLOCATED
PERSONNEL COSTS
ALLOCATION BASE
ALLOCATION RATIO
COSTS ALLOCATED
TOTAL ALLOCATION

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STEP-DOWN / SEQUENTIAL METHOD

PERSONNEL / CUTTING / ASSEMBLY / TOTAL

MAINTENANCE=$70K

ALLOCATION BASE
ALLOCATION RATIO
ALLOCATION / 2,000 SQR FT
2,000/20,000=10%
0.1 X 70K= $7,000* / 8,000 SQR F T
8,000/20,000=40%
0.4 X 70K=$28,000 / 10,000 SQR FT
10,000/20,000=50%
0.5 X 70K=$35,000 / 20,000
100%
$70,000

PERSONNEL=

$30K + $7K* = $37K

ALLOCATION BASE

ALLOCATION RATIO
ALLOCATION /
X
/ 120 EMPLOYEES
120/180 = 66.7%
0.667x37K=$24,679 / 60 EMPLOYEES
60/180 = 33.3%
0.333x37K=$12,321 / 180
100%
$37,000
TOTAL / $52,679 / $47,321 / $100,000

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