Question

Support-department cost allocations: single-department cost pools; direct, step-down, and reciprocal methods.
1	a.	Allocate the total Support Department costs to the production departments under the Direct Allocation Method:
		Clothing	Shoes
	Departmental Costs	$10,500	$7,500
	From:
	Information Technology
	(5040/9000)*2600	$1,456
	(3960/9000)*2600		$1,144
	Human Resources
	(220/308)*1400	$1,000
	(22/308)*1400		$400
	Total Departmental Costs	$12,956	$9,044
	Total Costs to account for:	$     22,000
b.	Allocate the Support Department Costs to the Production Department under the Step-down (Sequential) Allocation Method IT first sequentially:
	To:
		IT	HR	Clothing	Shoes
	Departmental Costs	$2,600	$1,400	$10,500	$7,500
	From:
	Information Technology	-$2,600
	(3000/12000)*2600		$650
	(5040/12000)*2600			$1,092
	(3960/12000)*2600				$858
	Human Resources		-$2,050
	(220/308)*2050			$1,464
	(88/308)*2050				$586
	Total Departmental Costs	$0	$0	$13,056	$8,944
	Total Costs to account for:	$     22,000
c.	Allocate the Support Department Costs to the Production Department under the Step-down (Sequential) Allocation Method HR first sequentially:
	To:
		HR	IT	Clothing	Shoes
	Departmental Costs	$1,400	$2,600	$10,500	$7,500
	From:
	Human Resources	-$1,400
	(92/400) _ $1,400		$322
	(220/400) _ $1,400			$770
	(88/400) _ $1,400				$308
	Information Technology		-$2,922
	(5,040/9,000) _ $2,922			$1,636
	(3,960/9,000) _ $2,922				$1,286
	Total Departmental Costs	$0	$0	$12,906	$9,094
	Total Costs to account for:	$     22,000
d.	Allocate the Support Department Costs to the Production Department under the Reciprocal Allocation Method:
	i. Assign reciprocal equations to the support departments
	IT=(2600+92 employees/400 employees*HR)
	IT   =	$2,600+0.23HR
	HR =	($1,400+.025 IT)
	HR=($1,400+3,000 hours/1,200 hours IT)
	ii. Solve the equation to complete the reciprocal costs of the support departments
	IT=$2,600+.023($1,400+0.25 IT)
	IT= $2,600+$322+0.0575IT
	0.9425 IT = $2,922
	IT =	$       3,100
	HR= $1,400+0.25 IT
	HR= $1,400+0.25(3,100)
	HR= $1,400+775
	HR =	$2,175
	iii. Allocate Reciprocal costs to departments (all numbers rounded to nearest dollar)
		IT	HR	Clothing	Shoes
	Departmental Costs	$2,600	$1,400	$10,500	$7,500
	Information Technology	-$3,100
	(3000/12000)*$3,100		$775
	(5040/12000)*$3,100			$1,302
	(3960/12000)*$3,100				$1,023
	Human Resources		-$2,175
	(92/400)*$2,175	$500
	(220/400)*$2,175			$1,196
	(88/400)*$2,175				$479
	Total Departmental Costs	$0	$0	$12,998	$9,002
			$     22,000
	Reciprocal Method of Allocating Support Department Costs for Sportz, Inc. Using Repeated Iterations.
		Support Departments		Operating Departments
		IT	HR	Clothing	Shoes
	Budgeted manufacturing overhead costs before any interdepartmental cost allocations
	1st Allocation of IT Dept.
	(0.25, 0.42, 0.33)b
	1st Allocation of HR Dept.
	2nd Allocation of IT Dept.
	2nd Allocation of HR Dept.
	3rd Allocation of IT Dept.
	3rd Allocation of HR Dept.
	4th Allocation of IT Dept.
	Total budgeted manufacturing
	overhead of operating departments

I understand the first half just not the both half.

Sportz, Inc., manufactures athletic shoes and athletic clothing for both amateur and professional athletes. The company has two product lines (clothing and shoes), which are produced in separate manufacturing facilities; however, both manufacturing facilities share the same support services for information technology and human resources. The following shows total costs for each manufacturing facility and for each support department.

	Variable Costs	Fixed Costs	Total Costs by Department
Information Technology	600	2,000	2,600
Human Resources	400	1,000	1,400
Clothing	2,500	8,000	10,500
Shoes	3,000	4,500	7,500
Total Costs	6,500	15,500	22,000

The total costs of the support departments (IT and HR) are allocated to the production departments (clothing and shoes) using a single rate based on the following:

Information technology: Number of IT labor-hours worked by department
Human resources: Number of employees supported by department

Data on the bases, by department, are given as follows:

Department		IT Hours Used		Number of Employees
Clothing		5,040		220
Shoes		3,960		88
Information technology		-		92
Human resources		3,000		-

What are the total costs of the production departments (clothing and shoes) after the support department costs of information technology and human resources have been allocated using (a) the direct method, (b) the step-down method (allocate information technology first), (c) the step-down method (allocate human resources first), and (d) the reciprocal method?

Assume that all of the work of the IT department could be outsourced to an independent company for $97.50 per hour. If Sportz no longer operated its own IT department, 30% of the fixed costs of the IT department could be eliminated. Should Sportz outsource its IT services?

Answer 1

Solution:

Cost Allocation - Direct method
Particulars	HR	IT	Clothing	Shoes
Department Cost	$1,400.00	$2,600.00	$10,500.00	$7,500.00
Allocation of support department cost:
HR (220:88)	-$1,400.00		$1,000.00	$400.00
IT (5040:3960)		-$2,600.00	$1,456.00	$1,144.00
Total	$0.00	$0.00	$12,956.00	$9,044.00

Cost Allocation - Step down method (First IT Allocation)
Particulars	HR	IT	Clothing	Shoes
Department Cost	$1,400.00	$2,600.00	$10,500.00	$7,500.00
Allocation of support department cost:
IT (3000:5040:3960)	$650.00	-$2,600.00	$1,092.00	$858.00
HR (220:88)	-$2,050.00		$1,464.29	$585.71
Total	$0.00	$0.00	$13,056.29	$8,943.71

Cost Allocation - Step down method (First HR Allocation)
Particulars	HR	IT	Clothing	Shoes
Department Cost	$1,400.00	$2,600.00	$10,500.00	$7,500.00
Allocation of support department cost:
HR (92:220:88)	-$1,400.00	$322.00	$770.00	$308.00
IT (5040:3960)		-$2,922.00	$1,636.32	$1,285.68
Total	$0.00	$0.00	$12,906.32	$9,093.68

Reciprocal method of allocation:

Service department cost = Direct Cost + Allocated Cost

IT Department Cost = $2,600 + [92 / (92+220+88)]* HR Cost

                                                    = $2,600 + 0.23*HR Cost

HR Cost = $1,400 + [3000 / (3000+5040+3960)]* IT Cost

                                             = $1,400 + 0.25 * IT Cost

HR Cost = $1,400 + 0.25 ($2,600 + 0.23*HR Cost)

HR Cost = $1,400 + $650 + 0.0575*HR Cost

HR Cost = $2,050 / 0.9425 = $2,175

IT Cost = $2,600 + 0.23*$2,175 = $3,100

Cost Allocation - Reciprocal method
Particulars	HR	IT	Clothing	Shoes
Department Cost	$1,400.00	$2,600.00	$10,500.00	$7,500.00
Allocation of support department cost:
HR (92:220:88)	-$2,175.00	$500.00	$1,196.00	$479.00
IT (3000:5040:3960)	$775.00	-$3,100.00	$1,302.00	$1,023.00
Total	$0.00	$0.00	$12,998.00	$9,002.00

Total nos of IT hours = 12,000

If IT department outsources then company will save variable cost of $600 and 30% fixed cost i.e.$600 (2000*30%)

Hence total saving = 600 + 600 = $1,200

Cost of outsourcing = 12000 * 97.50 = $1,170,000

Hence net saving = 1.200 - 1170000 = - $1,168,800

There is loss on outsourcing of IT department, therefore Sportz should not outsource their IT deptt