Question

Comprehensive Insurance Company has two products lines: health insurance and auto insurance.
The two products lines are served by three operating departments which are necessary for
providing the two types of products: claims processing, administration, and sales.
These three operating departments are supported by two departments: information
technology and operations. The support provided by information technology and operations
to the other department is shown below.
	Support Departments			Operating Departments
	IT	Operations		Claims Processing	Administration	Sales
IT		20%		20%	40%	20%
Operations	10%			10%	50%	30%
The total cost incurred in the five departments are:
IT	600,000
Operations	1,800,000
Claims processing	450,000
Administration	850,000
Sales	650,000
Total costs	4,350,000
Required
Use 4 or more decimals places (e.g., 33.3333%) in your calculations. Allocate the $4,350,000 total
departamental costs to the three operating departments using (a) the direct method, (b) the step
method (once for information technology and once for operations going first in the allocation), and
c) the reciprocal method.

Answer 1

Solution a:

From	Service Department Cost Allocation - Direct Method
	Service Department		Operating Departments
	IT	Operations	Claim Processing	Administartion	Sales
Direct charges of department	$600,000.00	$1,800,000.00	$450,000.00	$850,000.00	$650,000.00
IT (2:4:2)	-$600,000.00		$150,000.00	$300,000.00	$150,000.00
Operations (1:5:3)		-$1,800,000.00	$200,000.00	$1,000,000.00	$600,000.00
Total	$0.00	$0.00	$800,000.00	$2,150,000.00	$1,400,000.00

Solution b:

From	Service Department Cost Allocation - Step Method (Allocation of IT First)
	Service Department		Operating Departments
	IT	Operations	Claim Processing	Administartion	Sales
Direct charges of department	$600,000.00	$1,800,000.00	$450,000.00	$850,000.00	$650,000.00
IT (2:2:4:2)	-$600,000.00	$120,000.00	$120,000.00	$240,000.00	$120,000.00
Operations (1:5:3)		-$1,920,000.00	$213,333.33	$1,066,666.67	$640,000.00
Total	$0.00	$0.00	$783,333.33	$2,156,666.67	$1,410,000.00

From	Service Department Cost Allocation - Step Method (Allocation of operation First)
	Service Department		Operating Departments
	IT	Operations	Claim Processing	Administartion	Sales
Direct charges of department	$600,000.00	$1,800,000.00	$450,000.00	$850,000.00	$650,000.00
Operations (1:1:5:3)	$180,000.00	-$1,800,000.00	$180,000.00	$900,000.00	$540,000.00
Operations (2:4:2)	-$780,000.00		$195,000.00	$390,000.00	$195,000.00
Total	$0.00	$0.00	$825,000.00	$2,140,000.00	$1,385,000.00

Solution c:

Service department cost = Direct Cost + Allocated Cost

IT Department Cost = $600,000 + 0.10 * Operation Cost

                                                   

Operation Department Cost = $1,800,000 + 0.20 * IT Department Cost

                               

Operation department cost = $1,800,000 + 0.20 * ($600,000 + 0.10 * Operation Cost)

Operation department cost = $1,800,000 + $120,000 + 0.02*Operation Cost

Operation department cost = $1,920,000 / 0.98 = $1,959,184

IT Department Cost = $600,000 * $1,959,184 * 10% = $795,918

From	Service Department Cost Allocation - Reciprocal Method
	Service Department		Operating Departments
	IT	Operations	Claim Processing	Administartion	Sales
Direct charges of department	$600,000	$1,800,000	$450,000	$850,000	$650,000
IT (2:2:4:2)	-$795,918	$159,184	$159,184	$318,367	$159,184
Operations (1:1:5:3)	$195,918	-$1,959,184	$195,918	$979,592	$587,755
Total	$0	$0	$805,102	$2,147,959	$1,396,939