Managing and Allocating Support-Service Costs

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Chapter 10
Managing and Allocating Support-Service Costs


10.1The following factors should be considered when deciding whether to outsource a support service:

• cost

• quality, timeliness, and reliability

• security of sensitive information

• knowledge required

10.2Some of the costs of cost allocation include:

• additional bookkeeping;

• additional management costs in selecting allocation methods and allocation bases; and

• costs of making the wrong decision if the allocations provide misleading information.

10.3Some of the benefits of cost allocation include:

• instilling responsibility for all costs of the company in the division managers;

• relating indirect costs to contracts, jobs and products; and

• constructing performance measures (“net profit”) for a division that may be more meaningful to management than contribution margins.

10.4Aside from regulatory requirements, costs are allocated if the benefits of cost allocation exceed the costs incurred to make the allocation.

10.5Management often uses this type of information for performance evaluation and to assess long-run decisions. That is, in the long run, an activity (e.g., production) must recover all of its costs (both direct and indirect).

10.6Some common cost categories and allocation bases are:

|Cost Category | |Allocation Bases | |Labor-related costs | |number of employees | | | |labor hours | | | |wages paid | | | |some other labor-related base | |Machine-related costs | |machine hours | | | |current value of machinery | | | |number of machines | | | |some other machine-related base | |Space-related costs | |area occupied | | | |volume occupied | | | |some other space-related base | |Service-related costs | |computer time | | | |service hours | | | |some other service-related base |

10.7The essential difference is the allocation of costs among service departments. The direct method makes no inter-service-department allocation, the step method makes a partial inter-service-department allocation, while the reciprocal method recognizes inter-service-department activities.

10.8Allocations usually begin from the service department that has provided the greatest proportion of its services to other departments, or that services the greatest number of other service departments. This criterion is used to minimize the unrecognized portion of reciprocal service department costs. (Recall that the amount of service received by the first department to allocate in the step allocation sequence is ignored.)


10.9The answer probably depends on each party’s point of view. Sharing equally is simplest, but may not accurately reflect the use of housekeeping resources. Relative size...
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