Question

Departmental Cost Allocation; Not-for-Profit 

The Fleming Foundation is a charitable organization founded by Gaylord Fleming and Sandy Fleming. The Flemings intended for the charity to provide programs in health care for the elderly, particularly those in poverty. The two main program divisions of the foundation are mental health for the elderly and housing for the elderly. In  addition to these programs, the Foundation also provides health care educational programs and has a significant fund-raising effort to help the Foundation grow and accomplish the goals of the founders. The Foundation is organized into two main departments—education and program management. These departments are supported by two service departments—information technology (IT) and administration.

There are $418,000 of costs directly traceable to each of the four departments. An additional $65,000 of indirect costs are shared among the four departments—$50,000 of which is allocated to the departments based on direct labor-hours and $15,000 to the departments based on the number of personnel (head count) in the departments.

The cost, labor-hours, and head count in these departments in the most recent year are as follows:

IT serves Education, Administration, and Program Management 20%, 20%, and 60% of its time, respectively. Administration serves Education, IT, and Program Management 30%, 10%, and 60%, respectively.

The costs of the two main departments (Education and Program Management) are allocated to the two programs (Mental Health and Housing) as follows: the costs in education are allocated on the basis of labor-hours in the programs, while the costs in program management are allocated using the head count used in the two programs. The following table shows the labor hours and head count consumption by the two programs.

Answer 1

Departmental Cost Allocation:

It is the method or process which identifies and aggregates and assigns the cost to different cost objects. It is the process through which costs incurred in which costs incurred in the service departments are allocated to the production departments.

Mechanism of cost allocation involves:

• Accumulating the costs in different drivers or pools.

• Identifying the most appropriate basis / method for allocating the cost.

• Identifying the drivers to which the cost must be assigned.

a)

Direct Method:

Under the direct method the cost of service departments are allotted only to the production department in the ratio of the percentage for the allocation of production department only.

First Phase: Trace Direct costs and perform initial allocation of indirect costs

Second Phase:

The cost allocation of the departments in the three methods is as follows:

Third Phase: Allocate production department costs to programs:

b)

Step Method:

Under the step method the cost one service department is allocated to the second service department and the production department in the given ratio. The cost allocation of the second department is done in the direct method which includes the cost of the first department. The selection of the first and second service department is usually given in the question.

First Phase: Trace Direct costs and perform initial allocation of indirect costs

Second Phase:

Third Phase: Allocate production department costs to programs:

c)

Reciprocal Method:

It is the method where service costs are allocated to other departments that give full recognition to interdepartmental services.

The reciprocal method uses algebraic equation method for cost allocation.

The formulas are

Substituting value of AD in IT formula

Similarly AD would be $150,459 by substituting the value of IT in any of the equation above.

First Phase: Trace Direct costs and perform initial allocation of indirect costs

Second Phase:

Third Phase: Allocate production department costs to programs: