CHAPTER 16

SUPPORT ACTIVITY AND DUAL-RATE ALLOCATIONS

TRUE/FALSE
1. A line activity relates indirectly to producing services or products.
LO1 False A line activity directly relates to producing services or products.
2. In decentralized firms, it is likely that different managers oversee the activities
connected with the different cost pools.
LO1 True
3. Cost allocation rates serve as the explicit price for the services line managers
obtain from other line activities.
LO1 False Cost allocation rates serve as the implicit price for the services line
managers obtain from other support departments.
4. Electrical engineering is an example of a line activity that is fully traceable to
contracts undertaken at a Design Specialist Consulting Firm designing a multistory office complex.
LO1 True
5. The purchasing department is an example of a support activity for a
manufacturing company.
LO1 True
6. The reciprocal method of allocating support activity costs is conceptually the
most appealing method because it takes into account all of the reciprocity in
consumption.
LO2 True
7. Under the direct method of allocating support activity costs, any consumption by
other support departments are allocated to both support and line activities.
LO2 False Under the direct method of allocating support activity costs, any
consumption by other support departments is ignored.
8. The step-down method of allocating support activity costs begins by rankordering support activity cost pools according to some criterion.
LO2 True
9. The step-down method of allocating support activity costs is also referred to as
the rank-ordering method.
LO2 False The step-down method of allocating support activity costs is also
referred to as the sequential method.
10.A key step in performing a step-down allocation is to rank the line cost pools
according to an absolute criterion.
LO2 False A key step in performing a step-down allocation is to rank the support
cost pools according to some criterion. However, there is no absolute
criterion.

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Balakrishnan/Managerial Accounting, 2e
11.All three methods of allocating support activity costs (direct, step-down,
reciprocal) employ a single cost driver to allocate costs.
LO3 True
12.The direct and step-down methods of allocating support activity costs differ from
the reciprocal method in that the reciprocal method uses a dual-rate allocation.
LO3 False All three methods employ a single cost driver to allocate costs.
13.One answer to the problem of using a single cost driver to allocate support
activity costs is to use a dual-rate allocation.
LO3 True.
14.The cost driver used to allocate costs of support activities should bear an
economic relation to the revenue generated.
LO3 False The cost driver we use to allocate costs should bear an economic
relation with the cost we allocate.
15.It may be more appropriate for firms to employ long-term expected demand to
allocate fixed capacity costs, and actual demand to allocate short-term variable
costs.
LO3 True

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Support Activity and Dual-Rate Allocations

MULTIPLE CHOICE
16.In a consulting company specializing in designing multi-story office complexes,
which of the following activities would not be classified as support activity?
A. Shipping.
B. Purchasing.
C. Structural engineering.
D. Human resources.
E. All of the above would be support departments.
LO1 C
17.Accounting for reciprocity among support activities is important because:
A. It increases the accuracy of cost estimates.
B. It helps line managers become aware of the costs of the services they
consume.
C. It provides an explicit price for services obtained from support departments.
D. Both A and B.
E. A, B and C.
LO1 D
18.Pricing internal services from support activities is critical because:
A. Too high a price can lead managers to economize too much on a support
resource.
B. Too low a price can lead to wasteful consumption.
C. It allows managers to improve their bottom line through negotiation with
different support managers.
D. Both A and B
E. A, B and C.
LO1 D
19.A line activity:
A. Generally has its costs allocated to support activities.
B. Directly relates to producing services or products.
C. Must be allocated costs from all support activities, whether or not the line
activity consumed costs of the support activity.
D. Must be allocated costs from all support activities for which it consumed
costs.
E. None of the above is a correct statement relating to a line activity.
LO1 B
20.A support activity:
A. Is needed to run the business.
B. Is directly related to making or selling a product or service.
C. Must have all its costs allocated to a line activity.
D. Must have all its costs allocated to a line activity or another support activity.
E. None of the above is a correct statement relating to a support activity.
LO1 A

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Balakrishnan/Managerial Accounting, 2e
21.The salary expense of which of the following positions would not be considered
a support activity cost?
a. Payroll clerk
b. Project manager
c. Receptionist
d. Human resource director
LO1-Self test-B
22.Which of the following methods is not an acceptable method for allocating the
cost of support activities?
a. The step-down method
b. The reciprocal method
c. The indirect method
d. The direct method
LO2- Self testC
23.Which of the following is not a method used to allocate support activity costs?
A. Direct method.
B. Reciprocal method.
C. Step-down method.
D. Self-consumption method.
E. All of the above are methods used to allocate support activity costs.
LO2 D
24.When a support departments activities are not fully consumed by other
departments (that is, the support department self-consumes some costs):
A. We ignore such self-consumption.
B. Not allocating the self-consumption negatively affects the accuracy of
allocations.
C. We must allocate the self-consumption costs to line activities.
D. A and B only.
E. None of the above.
LO2 A
25.The costs of the Purchasing department are allocated based on the number of
purchase orders. In December, 1,350 purchase orders are issued for the
following departments:
Accounting (support)
250
Purchasing (support)
100
Engineering (line)
400
Masonry (line)
600
What is the consumption percentage for the Accounting department?
a. 20%
b. 25.9%
c. 18.5%
d. 71.4%
LO2-Self Test-A

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Support Activity and Dual-Rate Allocations

26.In a home construction company, support costs accumulated by the IT
department can be allocated to all except which of the following departments
when using the direct method?
a. Design
b. Electrical
c. Masonry
d. Purchasing
LO2-Self Test-D
27.It has been determined that Administrative costs of $6,300 have been consumed
on a percentage basis by the following departments:
Accounting (support)
20%
Engineering (line)
30%
Masonry (line)
50%
Using the direct method, how much of the administrative costs will be allocated
to the Engineering department (rounded)?
a. $5,040
b. $1,890
c. $2,363
d. $3,938
LO2-Self Test-C
28.Assume Porters Consulting uses the number of purchase orders as the cost
driver for allocating purchasing costs of $285,000. If Porter issues 1,000
purchase orders, including 300 used by line activity one, 400 used by line
activity two, 50 for supplies used by purchasing itself, and 250 used by
administration, how much of the cost will be allocated to line activity two using
the direct method of allocation?
A. $199,500
B. $114,000
C. $162,857
D. $195,000
E. None of the above.
LO2 C
29.When using the direct method why would companies choose to perform the
allocation with predetermined rates?
a. To better communicate the often-forgotten cost of support services to
department managers
b. To make the budgeting process easier for managers
c. To influence a department managers hiring policies
d. To persuade company executives to cut costs
LO2-Self Test-A

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Balakrishnan/Managerial Accounting, 2e
30.The costs of the Purchasing department ($140,625) are allocated based on the
number of purchase orders. In December, 2,400 purchase orders are issued in
support of the following departments:
IT (support)
100
Purchasing (support)
50
Packaging (line)
1,750
Fabrication (line) 500
Using the direct method, what will be the cost per purchase order?
a. $58.59
b. $62.50
c. $51.06
d. $52.17
LO2-Self Test-B
31.When using the step-down method what is an appropriate method to rank the
cost pools?
a. From the cost pool with the lowest budgeted costs to the cost pool with the
highest budgeted costs
b. From managements intuitive determination which can be based on a variety
of factors
c. From the cost pool with the fewest employees to the cost pool with the most
employees
d. All of these are acceptable methods as long as they are applied consistently
LO2-Self test-D
32.For the month of October, the Accounting and IT departments incurred costs of
$180,000 and $260,000, respectively. The company uses the step-down method
to allocate support costs with the accounting costs being allocated first followed
by the IT costs. Costs are being consumed in the following manner:
Accounting Costs
IT Costs
IT
20%
Accounting
20%
Mixing
35%
Mixing
30%
Fabrication
25%
Fabrication
20%
Final Cost Objects 20%
Final Cost Objects 30%
Using the step-down method, how much of the total support activity costs
(Accounting and IT) will be allocated to the Fabrication department?
a. $119,000
b. $104,200
c. $97,000
d. $99,900
LO2-Self test-A
33.The Wilson Manufacturing Company uses the step-down method for allocating
support costs and the company has three support departments, Maintenance,
Human Resources, and Cafeteria. Assuming that the company allocates costs in
that same order, the costs allocated from the cafeteria to line departments and
final projects will include:
a. Maintenance, cafeteria and human resource costs
b. Only cafeteria costs
c. Only cafeteria and human resource costs

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Support Activity and Dual-Rate Allocations

d. Only human resource and maintenance costs
LO2-Self test-A
34.The reciprocal method of allocating support costs is considered superior to other
methods because:
a. It is the easiest method to implement
b. It spreads support costs among cost pools based on the current number of
employees
c. It takes into account all of the reciprocity in consumption between various
departments
d. It ignores administrative costs because they are assumed to be shared
equally by all departments
LO2-Self test-C
35.Assume Potters Manufacturing has a Janitorial Department that supports the
Maintenance Department and two line activity departments, Department A and
Department B. Janitorial and Maintenance are allocated to other departments on
the basis of square footage of space used. The amount of space used by each
department is listed below:
Department
Janitorial
Maintenance
Department A
Department B

Square Footage
Used
600
900
4,500
9,000

The expected cost for the Janitorial Department is expected to be $9,000. Using
the step-down method, what is the amount of janitorial costs will be allocated to
Maintenance?
a. $0
b. $540
c. $562.50
d. $5,400
e. None of the above.
LO2 C
36.The step-down method of allocation improves the direct method by:
a. Considering the reciprocity in consumption partially.
b. Simplifying the allocation approach.
c. Allocating more of the total cost of the service activity.
d. Using a statistical approach to allocation.
e. None of the above.
LO2 A

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Balakrishnan/Managerial Accounting, 2e
37.The XYZ Manufacturing Company has two support activity pools, Accounting (A)
and Human Resources (H). Costs for each totaled $420,000 and $270,000
respectively. 20% of the Human Resource costs are consumed by the
Accounting department and 10% of the Accounting department costs are
consumed by the human resource department. If the company is using the
reciprocal method of allocating support costs, the total costs for the Accounting
department can be stated as:
a. $420,000 + .10 x ($270,000 + .20 x H)
b. $420,000 + .20 x ($270,000 +.10 x A)
c. $420,000 + .10 x ($420,000 + .10 x A)
d. $420,000 x .20 x ($270,000 + .10 x A)
LO2-Self test-B

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Support Activity and Dual-Rate Allocations

38.The XYZ Manufacturing Company has two support activity pools, Accounting and
Human Resources. Costs for each totaled $380,000 and $190,000 respectively.
10% of the Human Resource costs are consumed by the Accounting department
and 15% of the Accounting costs are consumed by the human resource
department. The company uses the reciprocal method of allocating support
costs. The total costs for the Accounting department which will be allocated to
line activities and cost objects will be:
a. $399,000
b. $405,076
c. $414,721
d. $231,472
LO2-Self test-B
39.The XYZ Manufacturing Company has two support activity pools, Accounting and
Human Resources. Costs for each are $380,000 and $190,000 respectively. 10%
of the Human Resource costs are consumed by Accounting and 15% of the
Accounting costs are consumed by Human Resources. The company uses the
reciprocal method of allocating support costs. The total costs for the Human
Resources department which will be allocated to line activities and cost objects
will be:
a. $250,761
b. $252,208
c. $247,000
d. $249,850
LO2-Self test-A
40.Westminster Manufacturing Company has two support activities and two line
activities. The following data pertain to usage patterns for the support and line
activities:
Support Activities
Line Activities
Human
Maintena Resourc
Activity
nce
es
Activity A
B
Costs
$40,000
$20,000
$100,000
$200,00
0
Square Footage
300
400
1,000
3,000
Used
Number of
10
20
100
150
Employees
Direct Labor Hours
2,000
4,000

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Balakrishnan/Managerial Accounting, 2e
The costs of Maintenance are allocated based on square footage used. Human
Resources costs are allocated based on number of employees. Activity A and B
costs are overhead costs with predetermined overhead rates computed based on
direct labor hours. If the company uses the direct method of allocating support
activities to line activities, what fraction of Maintenance will be allocated to
Activity A?
a. 1/4
b. 1/4.7
c. 1.7/4.7
d. 3/7
e. None of the above.
LO3 A
41.Westminster Manufacturing Company has two support activities and two line
activities. The following data pertain to usage patterns for the support and line
activities:
Support Activities
Line Activities
Human
Maintena Resourc
Activity
nce
es
Activity A
B
Costs
$40,000
$20,000
$100,000
$200,00
0
Square Footage
300
400
1,000
Used
3,000
Number of
10
20
100
Employees
150
Direct Labor Hours
2,000
4,000
The costs of Maintenance are allocated based on square footage used. Human
Resources costs are allocated based on number of employees. Activity A and B
costs are overhead costs with predetermined overhead rates computed based on
direct labor hours. If the company uses the direct method of allocating support
activities to line activities, what is the predetermined overhead rate for Activity
B?
a. $50
b. $60
c. $60.50
d. $10
e. None of the above.
LO2 C
42.Westminster Manufacturing Company has two support activities and two line
activities. The following data pertain to usage patterns for the support and line
activities:
Support Activities
Line Activities
Human
Maintena Resourc
Activity
nce
es
Activity A
B
Costs
$40,000
$20,000
$100,000
$200,00
0

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Support Activity and Dual-Rate Allocations

Square Footage
Used
Number of
Employees
Direct Labor Hours

300

400

1,000

10

20

100

3,000
150
2,000

4,000
The costs of Maintenance are allocated based on square footage used. Human
Resources costs are allocated based on number of employees. Activity A and B
costs are overhead costs with predetermined overhead rates computed based on
direct labor hours. If the company uses the step-down method of allocating
support activities to line activities and allocates the cost of Maintenance first,
what fraction of Human Resources costs will be allocated to Activity B?
a. 5/6
b.
1/4
c.
3/5
d. 1/3
e. None of the above.
LO2 C
43.The Peterson Company maintains a gym for its employees use. In August, the
cost of operations was budgeted at $12 per employee based on an average of
400 employees. During the month 380 employees worked in departments
outside of the gym and actual costs totaled $6,000. How much of the cost of the
gym should be allocated to other departments at the end of the month?
a. $6,316
b. $6,000
c. $4,800
d. $4,560
LO2-Self test-D
44.Westminster Manufacturing Company has two support activities and two line
activities. The following data pertain to usage patterns for the support and line
activities:
Support Activities
Line Activities
Human
Maintena Resourc
Activity
nce
es
Activity A
B
Costs
$40,000
$20,000
$100,000
$200,00
0
Square Footage
300
400
1,000
Used
3,000
Number of
10
20
100
Employees
150
Direct Labor Hours
2,000
4,000
The costs of Maintenance are allocated based on square footage used. Human
Resources costs are allocated based on number of employees. Activity A and B
costs are overhead costs with predetermined overhead rates computed based on
direct labor hours. If the company uses the step-down method of allocating

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Balakrishnan/Managerial Accounting, 2e
support activities to line activities and allocates the cost of Maintenance first,
what amount of Human Resources costs will be allocated to Activity A?
A. $8,000
B. $9,454
C. $20,000
D. $4,545
E. None of the above.
LO3 B
45.Westminster Manufacturing Company has two support activities and two line
activities. The following data pertain to usage patterns for the support and line
activities:
Support Activities
Line Activities
Human
Maintena Resourc
Activity
nce
es
Activity A
B
Costs
$40,000
$20,000
$100,000
$200,00
0
Square Footage
300
400
1,000
Used
3,000
Number of
10
20
100
Employees
150
Direct Labor Hours
2,000
4,000
The costs of Maintenance are allocated based on square footage used. Human
Resources costs are allocated based on number of employees. Activity A and B
costs are overhead costs with predetermined overhead rates computed based on
direct labor hours. If the company uses the step-down method of allocating
support activities to line activities and allocates the cost of Maintenance first,
what amount of total support activity costs will be allocated to Line Activities?
A. $60,000
B. $20,000
C. $40,000
D. $48,000
E. None of the above.
LO3 A

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Support Activity and Dual-Rate Allocations

Problems
1. To properly allocate cost, it is important to maintain separate cost pools for
line activities and support activities. It is important to distinguish between
the two activities. Indicate by placing an X in the appropriate column
whether each of the following items describes a line activity or a support
activity.
Required:
Line
Activity
_____

Support
Activity
_____

_____

_____

Finishing Department in a manufacturing company

_____

_____

Production Department in a factory

_____

_____

Maintenance Department

_____

_____

Janitorial Department

_____

_____

Maternity department in a hospital

g
.

_____

_____

The sporting goods department in a department

store

h
.
i.

_____

_____

Cafeteria for an insurance company

_____

_____

Employee Training for a manufacturer

j.

_____

_____

Tax department in a CPA firm

a
.
b
.
c
.
d
.
e
.
f.

Descriptions
Personnel Department

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Balakrishnan/Managerial Accounting, 2e
2. City Hospital has two support activities, Admissions and Technology Support, and
three line activities, Surgery, Rehab, and Therapy. City allocates the cost of
Admissions on patient days and Technology Support on number of reports
generated. The following data pertain to usage patterns for the support and line
activities for the current period:

Costs

Support Activities
Admissi Technolo
ons
gy
$28,000
$18,000

Patient Days
Number of Reports

Line Activities
Surger
Therap
y
Rehab
y
$180,00 $150,0 $190,00
0
00
0
16,000 23,000
17,000
5,000
7,000
8,000

Required:
a. Prepare a schedule to allocate support activity costs to line activities using the
direct method. Round answers to nearest dollar.
b. What is the total cost for Surgery for the current period?
c. What is the amount of Admissions allocated to Rehab for the current period?
d. What is the amount of Technology allocated to Therapy for the current period?

3. City Hospital has two support activities, Admissions and Technology Support, and
three line activities, Surgery, Rehab, and Therapy. City allocates the cost of
Admissions on patient days and Technology Support on number of reports
generated. The following data pertain to usage patterns for the support and line
activities for the current period:

Costs
Patient Days
Number of Reports

Support Activities
Admissi Technolo
ons
gy
$28,000
$18,000
150

500

Line Activities
Surger
Therap
y
Rehab
y
$180,00 $150,0 $190,00
0
00
0
16,000 23,000
17,000
5,000
7,000
8,000

Required:
a. Prepare a schedule to allocate support activity costs to line activities using the
step-down method allocating technology first. Round answers to nearest dollar.
b. What is the total cost for Surgery for the current period?
c. What is the amount of Technology allocated to Rehab for the current period?
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Support Activity and Dual-Rate Allocations

d. What is the amount of Admissions allocated to Therapy for the current period?

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Balakrishnan/Managerial Accounting, 2e
Problem solutions
1. Line and Support Activities (LO1)
Line
Activity
_____

Support
Activity
___x__

__x___

_____

Finishing Department in a manufacturing company

__x___

_____

Production Department in a factory

_____

__x___

Maintenance Department

_____

__x___

Janitorial Department

__x___

_____

Maternity department in a hospital

g
.

__x___

_____

The sporting goods department in a department

store

h
.
i.

_____

__x___

Cafeteria for an insurance company

_____

__x___

Employee Training for a manufacturer

j.

__x___

_____

Tax department in a CPA firm

a
.
b
.
c
.
d
.
e
.
f.

Descriptions
Personnel Department

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Support Activity and Dual-Rate Allocations

2. Direct Method (LO2)
a. Schedule to allocate support activities:
Support Activities
Admissi Technolo
ons
gy
$28,000
$18,000

Costs
Patient Days
Allocation

($28,000
)

Number of
Reports
Allocation
Costs after
allocation

$0

($18,000)
$0

Line Activities
Surger
Therap
y
Rehab
y
$180,00
$150,000 $190,00
0
0
16,000
23,000
17,000
$8,000
$11,500
$8,500
5,000

7,000

8,000

$4,500
$192,5
00

$6,300
$167,800

$7,200
$205,7
00

b. Total cost for Surgery

$192,500
c. Admissions allocated to Rehab
$11,500
d. Technology allocated to Therapy
$7,200
3. Step-Down Method (LO2)
a. Schedule to allocate support activities:
Support Activities
Technolo Admissio
gy
ns
$18,000
$28,000

Costs
Reports
Allocation
Total
Patient Days
Allocation
Costs after
allocation

500
($18,000)

$0

150
$134
$28,134
($28,134)
$0

b. Total cost for Surgery

$192,505
c. Technology allocated to Rehab
$6,253

16-17

Line Activities
Surger
Therap
y
Rehab
y
$180,00
$150,000 $190,00
0
0
5,000
7,000
8,000
$4,467
$6,253
$7,146
16,000
$8,038
$192,5
05

23,000
$11,555
$167,808

17,000
$8,541
$205,6
87

Balakrishnan/Managerial Accounting, 2e
d. Admissions allocated to Therapy
$8,541

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Support Activity and Dual-Rate Allocations

End of Chapter Content
Short Answer
1. What is the distinction between a line activity and a support activity? Give two
examples of each.
2. What complicates the allocation of support activity costs?
3. What are the three methods for allocating the costs of support activities?
4. Name one important difference between the step-down method and the direct
method?
5. Does changing the order in which we allocate the costs of support activities
matter under the step down method? Does it matter for the direct or reciprocal
methods?
6. How do we account for the self-consumption of resources (e.g., the power
consumed by the Power Generation Department, or the Payroll Department
processing checks for the employees in human resources) when we perform a
step-down allocation?
7. Name one important difference between the reciprocal method and the stepdown method.
8. Describe the dual-rate allocation method.
9. In a dual-rate allocation, what is the allocation basis for allocating capacity costs?
For operating costs?
10.What is the advantage of using budgeted instead of actual costs when
determining the overhead rates to employ for allocating the costs of support
activities?

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Balakrishnan/Managerial Accounting, 2e
Short Answer Solution
1. (LO-1)
A line activity directly relates to producing services or products,
whereas a support activity is not directly related to making or selling a product
or service. Examples of a line activity include engineering, machining, and
assembly. Examples of a support activity include accounting and payroll.
2. (LO-1)
The reciprocity in consumption among support activities such
departments not only provide services for line activities, but also for each other.
3. (LO-2)
(1) the direct method, (2) the step-down method, and (3) the reciprocal
method.
4. (LO-2)
The direct method ignores reciprocity in consumption, whereas the
step-method partially accounts for it.
5. (LO-2)
Changing the order matters for the step-down method, but it does not
for the direct and reciprocal methods.
6. (LO-2)

We ignore such self-consumption.

7. (LO-2)
The step-method partially accounts for reciprocity in consumption,
whereas the reciprocal method fully accounts for it.
8. (LO-3)
The dual-rate allocation method uses two pools, one for long-term or
fixed costs and one for short-term or variable costs, to allocate costs from a
department. This dual-rate, or two-factor, allocation informs managers about the
different controllability of the costs.
9. (LO-3)
We allocate capacity costs using expected demand and operating costs
using actual demand.
10.(LO-3)
Using rates set on budgets instead of actual costs prevents cost
inefficiencies being passed on to user departments. Rather, they are isolated in
the cost center, potentially permitting superior control.

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Support Activity and Dual-Rate Allocations

Short Essays
1. What is the implicit time horizon that we assume when we allocate support
activity costs to other cost objects such as products and other activities?
2. We rank support departments when using the step-down method. Alternate
ranking criteria include department size, number of other departments serviced,
and arbitrary ranking. Which method will usually produce the smallest errors,
relative to the answers obtained from the conceptually accurate reciprocal
method?
3. Why do we prefer to use predetermined rates to charge out support department
costs to other departments?
4. What is the key difference between an allocation from a support department and
a transfer price? Does this distinction matter for pricing the service? For
evaluating responsibility center managers?
5. Suppose a support activity allocated all of its costs based on actual usage of its
services and use of actual rates. In this scenario, how does the activity volume in
one department affect the costs allocated to other activities? Why is such
dependence undesirable?
6. Would the issue in the above question become moot if we employed
predetermined overhead rates? Why does the answer depend on whether the
decline in volume was predictable?
7. Under the dual-rate system, expected long term demand is the allocation basis
for allocating the capacity costs of support activities. What incentives does this
provide to managers of line activities?
8. How could we accommodate the use of batch-and product-level costs in a dualrate allocation system?
9. Would a dual-rate allocation make sense for allocating facility level costs? Why
or why not?

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Balakrishnan/Managerial Accounting, 2e
Short Essay Solutions
1. (LO-1)
When we allocate support activity costs, we are in essence assuming
that the support resource have positive opportunity costs over the relevant
horizon. For short-term decisions, we must include only those support costs that
are controllable in the short term (e.g., variable support costs). For long-term
decisions such as product planning and capacity planning, it makes sense to
allocate capacity costs of support activities as well under the assumption that
these costs are controllable over that horizon.
2. (LO-2)
We cannot say for sure. Allocating the support department of the
largest size first -- or the support department that provides the most support
(transaction volume, support department involving expensive resources) first -typically give rise to small errors because the cost of reciprocal services from
other departments is likely to be less material.
3. (LO-3)
Predetermined overhead rates are based on budgeted usage. So they
insulate each department from other departments actual usage patterns. They
can be computed at the time budgets are prepared. They are convenient to
implement because each department is charged for its requested usage for
support department resources in a timely fashion, much like a transfer price.
4. (LO-1)
Transfer price is a term used to refer to the price of internal transfers of
goods and services between two profit centers of a company. Service
department cost allocations yield cost rates charged to individual departments
for using different services. From the perspective of a profit center using these
services, there is not much difference between a transfer price and allocated
service department costs. Both in essence represent the price for use of some
input, whether it is a product or a service supplied by another profit center, or by
a service department. Allocating service department costs to a profit center
would induce its managers to use these services in effective and efficient ways.
5. (LO-3)
Use of actual usage and actual rates to allocate service department
costs will result in one departments usage affecting the cost allocated to the
other departments. To see why, assume that all departments use the services of
a service department as planned except one department whose usage is far less
than anticipated. Assuming that most of the service departments costs are fixed
in the short run, a decline in usage increases the actual cost rates, and the
amounts allocated to other departments (even though as noted earlier their
usages have been as planned). This can be problematic especially when the
departments are profit centers, and the profit of a department falls for no
apparent reason!

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Support Activity and Dual-Rate Allocations

6. (LO-3)
Yes, the use of predetermined overheads does solve the problem to an
extent because predetermined rates are based on budgeted, not actual, volume.
So varying usage by one department does not affect the costs allocated to other
departments. However, the problem does not completely go away because
budgeted volume can change from period to period depending on business
conditions, predetermined rates can also fluctuate from period to period. In other
words, if a department budgets that its usage will be less for the coming period,
then all else equal, the predetermined overhead rate will increase, and more of
the service departments costs will be distributed to other departments.
7. (LO-3)
A natural incentive for managers of line activities is to under-report
their demand so that they are allocated less of the support departments
capacity costs, but risk having to pay a premium for the services as and when
demand outstrips their initial request for support capacity resources.
8. (LO-3)
At a conceptual level, we can consider a single-rate allocation as
viewing all costs being allocated as being variable in the chosen cost driver. A
dual rate allocation is then best viewed as modeling the costs as fixed and
variable costs, with separate drivers. Introducing product- and batch-level costs
imposes a finer cost model. We can then use more drivers that capture that
consumption of batch- and product-level resources. That is, we might have to
resort to a system that has three or four-rates, one for each kind of cost.
9. (LO-3)
We argue that allocating facility level costs is not a useful exercise
from a decision making perspective because these costs are not controllable for
decisions that view the business as a going concern. Thus, the issue of how to
allocate is moot. Nevertheless, many firms do allocate facility level costs to
make the allocation complete. In such cases, separating facility level costs and
allocating them as a lump-sum to the user divisions (departments) is perhaps
the best way to highlight the uncontrollable nature of these costs.

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