Prepared by: Brian Christian S.

Villaluz, CPA
Service Department Cost Allocations
Two types of overhead costs:
1 Directly related to the operating activities (primary revenue generating)
2 Indirectly related to the operating activities
Support departments include both service and administrative departments.
o Service department an organizational unit that performs functional tasks for other
internal units.
o Administrative department perform management activities that benefit the entire
organization.
METHODS OF ALLOCATING SERVICE DEPARTMENT COSTS
1 Direct method assigns support department costs only to producing departments.
- the simplest allocation method.
- No consideration is given to service performed by one service
department for another service department.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

Step method allows a partial recognition of the effects of interaction among

support departments.
- No cost is assigned to service departments whose costs have already
been allocated.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

Benefits-provided ranking begins with the support department providing the most
service to all other support areas and ends with the support department providing the least
service to all other support areas.
o Those of the service department that provides the highest percentage of its total
services to other service departments.
o Another is to begin with the costs of the service department providing services to the
greatest number of other service departments.
o Another is to begin with the service department having the greatest peso cost of
services provided to other service departments.
3

Algebraic method considers all departmental interrelationships and reflects these

relationships in simultaneous equations.

Prepared by: Brian Christian S. Villaluz, CPA

-

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

the most complex of all the allocation techniques but it is the most
theoretically correct and provides the most accurate and reliable
allocations.

Prepared by: Brian Christian S. Villaluz, CPA

ACTIVITY-BASED COSTING (ABC)

Problem 1:
Weng Office Equipment Corporation manufactures two types of filing cabinets Deluxe and Executive and
applies manufacturing overhead to all units at the rate of P80 per machine hour. Production information follows:
Deluxe:
Executive:
Direct material cost
P40
P65
Direct labor cost
25
25
Budgeted volume (units)
16,000
30,000
The controller, who is studying the use of activity-based costing, has determined that the firms overhead can be
identified with three activities: manufacturing setups, machine processing, and product shipping. Data on the
number of setups, machine hours, and outgoing shipments, which are the activities three respective cost drivers,
follow:
Deluxe:
100
32,000
200

Setups
Machine hours
Outgoing shipments

Executive:
60
45,000
150

TOTAL:
160
77,000
350

The firms total overhead is subdivided as follows: manufacturing setups, P1,344,000; machine processing,
P3,696,000; and product shipping, P1,120,000.
1.
2.
3.
4.
5.

Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using the companys
current overhead costing procedures.
Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using activity-based
costing.
Is the cost of the Deluxe filing cabinet overstated or understated (i.e. distorted) by the use of machine
hours to allocate total manufacturing overhead to production? By how much?
Calculate the aggregate amount by which the Deluxe cabinet line is undercosted by the companys
current traditional overhead costing procedures. Then calculate the aggregate amount by which the
traditional system overcosts the Executive cabinet line.
Assume that the current selling price of a Deluxe filing cabinet is P270 and the marketing manager is
contemplating a P30 discount to stimulate volume. Is this discount advisable?

Problem 2:
The following data are for the two products produced by Aplan Company:
Direct materials
Direct labor hours (DLH)
Machine hours (MH)
Batches
Volume
Engineering modifications
Number of customers
Market price

Product A:
P15/unit
0.3 DLH/unit
0.1 MH/unit
125 batches
10,000 units
12 modifications
500 customers
P30/unit

Product B:
P24/unit
1.6 DLH/unit
1.2 MH/unit
225 batches
2,000 units
58 modifications
400 customers
P120/unit

The companys direct labor rate is P20 per DLH. Additional information follows:
Indirect manufacturing
Engineering support

Costs:

Driver:

P24,500

Engineering modifications

Prepared by: Brian Christian S. Villaluz, CPA

Electricity
Setup costs
Non-manufacturing:
Customer service
1.
2.

3.
4.
5.

34,000
52,500

Machine hours
Batches

81,000

Number of customers

Compute the manufacturing cost per unit using the plant-wide overhead rate based on direct labor
hours. What is the gross profit per unit?
How much gross profit is generated by each customer of Product A using the plant-wide overhead
rate? How much gross profit is generated by each customer of Product B using the plant-wide
overhead rate? What is the cost of providing customer service to each customer? What information is
provided by this comparison?
Determine the manufacturing cost per unit of each product line using ABC. What is the gross profit
per unit?
How much gross profit is generated by each customer of Product A using ABC? How much gross
profit is generated by each customer of Product B using ABC? Is the gross profit per customer
adequate?
Which method of product costing gives better information to managers? Why?

SERVICE DEPARTMENT COSTS ALLOCATION

Adidas Inc. is exploring ways to allocate the cost of service departments such as Quality Control and Maintenance to
the production departments such as Machining and Assembly. The controller of the company has provided the
following information:

Budgeted overhead
costs before allocation
Budgeted machine
hours
Budgeted direct labor
hours
Budgeted hours of
service of quality
control
Budgeted hours of
service of maintenance
1.
2.
3.
4.

Quality
control
P350,000

Maintenance

Machining

Assembly

TOTAL:

P200,000

P400,000

P300,000

P1,250,000

50,000 hours

50,000 hours

25,000 hours

25,000 hours

7,000 hours

21,000 hours

7,000 hours

35,000 hours

10,000 hours

18,000 hours

12,000 hours

40,000 hours

Under direct method of allocating service department costs, what are the total service costs allocated
to the machining and assembly departments, respectively?
Under the step-down method of allocating service department costs from quality control to
maintenance, what are the total service costs allocated to the machining and assembly departments,
respectively?
Under the reciprocal method of allocating service department costs, what are the total service costs
allocated to the machining and assembly departments, respectively?
In relation to item no. 3, what are the total service costs allocated to the machining and assembly
departments, respectively?
END

Prepared by: Brian Christian S. Villaluz, CPA

AFAR Answer Key

PROBLEM 1 Answers:
1. Deluxe P225/unit; Executive P210/unit
2. Deluxe P253.50/unit; Executive P194.80/unit
3. Understated by P28.50/unit
4. Deluxe P456,000 undercosted; Executive P456,000 overcosted
5. No.
PROBLEM 2 Answers:
1.
A
Mfg. cost/unit
26.37
Gross profit/unit
3.63
2.
Gross profit/customer
Customer service/customer
3..
Mfg. cost/unit
Gross profit/unit

A
24.29
5
5.705

4. Yes
Gross profit/customer
Customer service/customer
5.

ABC

PROBLEM 3 Answers:
1. P382,500; P167,500
2. P372,000; P178,000
3. P421,053; P284,211
4. P380,527; P169,474

B
84.65
35.35
A
72.60
90

B
176.80
90

B
95.02
5
24.97
5
A
114.1
0
90

B
124.87
5
90