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Support service department cost allocation – theoretical background
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Practical examples for allocating costs but also theoretical knowledge. Numerical step-by-steps and many diagrams
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Managerial Accounting 16.11.20Support service department cost allocation – theoretical background
The service cost challenges
o Goal of an organisation is to achieve objectives that prompted the creation of the
organisation
o Achieving the goals requires using scare resources and making complex trade-offs
amount competing uses
o Since cost allocation is arbitrary, does it matter how support service costs are allocated in
an organisation?
- Main production
departments: carry out
production process
- Support service
department: provide
support services to
main production
departments (HR, accounting) - These can be outsourced
Managing internal support service costs
o Alternatives:
- Do not charge internal customer for support services and recover the costs from
general revenues (No restriction however, for how much the main production
departments use the support services)
- Charge the cost of support services to using departments who use the services and
possibly recover the costs from these internal customers (provides correct incentives)
Distinguishing between production and support service departments
o Production departments:
- Carry out the goals of an organisation by providing good and services directly to
customers
- Main departments of company which manufacture products
o Support service departments:
, Managerial Accounting 16.11.20
- Provide support that facilitates the activities of production departments (Information
technology)
- Only generate costs
o Reasons for allocating service costs:
- Required reporting (should be possible to evaluate different department performance)
- Cost based contracts
- Influencing behaviour (if internal support departments are not paying for the service,
they may not have the correct incentives)
Cost object (department,
product)
Allocating support service costs – practical application
Cost allocation from service departments to internal customers
1) Identify the costs to be allocated to internal customers (cost incurred by support
service departments)
2) Choose the appropriate allocation base and rate (how much to allocate)
3) Measure the consumption of the allocation base in the production departments
(compute the monetary value of support service costs)
4) Allocate service department costs based on consumption
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