Question

HomeLife Life Insurance Company has two service departments (actuarial and premium rating) and two production departments (advertising and sales). The distribution of each service department’s efforts (in percentages) to the other departments is shown in the following table:

	To
From	Actuarial			Premium Rating			Advertising			Sales
Actuarial		—			80	%		10	%		10	%
Premium		20	%		—			20			60

The direct operating costs of the departments (including both variable and fixed costs) are:

Actuarial	$	89,000
Premium rating		24,000
Advertising		69,000
Sales		49,000

Required:

1. Determine the total costs of the advertising and sales departments after using the direct method or allocation.

2. Determine the total costs of the advertising and sales departments after using the step method of allocation.

3. Determine the total costs of the advertising and sales departments after using the reciprocal method of allocation.

Answer 1

Answer :

1.Direct Allocation

	Service Department	Production Department
	Acturial	Premium Rating	Advertising	Sales
Departmental cost before allocation	$ 89000	$ 24000	$ 69000	$ 49000
Allocation
Acturial Department (10 :10)	- $ 89000		$ 44500	$ 44500
Premium Rating Department ( 20: 60)		- $ 24000	$ 6000	$ 18000
Total cost	$ 0	$ 0	$ 119500	$ 111500

2. step method of allocation.

	Service Department	Production Department
	Acturial	Premium Rating	Advertising	Sales
Departmental cost before allocation	$ 89000	$ 24000	$ 69000	$ 49000
Allocation
Acturial Department (80: 10 :10)	- $ 89000	$ 71200	$ 8900	$ 8900
Premium Rating Department ( 20: 60)		- $ 95200	$ 23800	$ 71400
Total cost	$ 0	$ 0	$ 101700	$ 129300

Note -1

Acturial Department cost is allocated first since it provides highest % of service .

3.reciprocal method of allocation.

	Service Department	Production Department
	Acturial	Premium Rating	Advertising	Sales
Departmental cost before allocation	$ 89000	$ 24000	$ 69000	$ 49000
Allocation
Acturial Department ( 80:10:10)	- $ 111667	$ 89334	$ 11167	$ 11167
Premium Rating Department (20: 20:60)	$ 22667	$ 113334	$ 22666	$ 68000
Total cost	$ 0	$ 0	$ 102833	$ 128167

Note -2

Let A = Acturial Department cost

P = Premium Rating Department cost

A = $ 89000+ 20% of P

P = $ 24000 + 80 % of A

A = $ 89000 + 20% ( $ 24000 + 80% A)

A = $ 89000 + $ 4800 + 0.16 A

A = $ 111667

P = $ 113334

Note -3

All answer rounded to nearest Dollar .

$ 1 Difference arise due to rounding in premium rating department.