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		—			70	%		15	%		15	%
Premium		20	%		—			20			60

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

Actuarial	$	93,000
Premium rating		28,000
Advertising		73,000
Sales		53,000

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

Solution 1:

From	Service Department Cost Allocation - Direct Method
	Service Department		Production Departments
	Actuarial	Premium rating	Advertising	Sales
Direct charges of department	$93,000	$28,000	$73,000	$53,000
Actuarial (1:1)	-$93,000		$46,500	$46,500
Premium (20:60)		-$28,000	$7,000	$21,000
Total	$0	$0	$126,500	$120,500

Solution 2:

From	Service Department Cost Allocation - Step Method (Allocation of Actuarial First)
	Service Department		Production Departments
	Actuarial	Premium rating	Advertising	Sales
Direct charges of department	$93,000	$28,000	$73,000	$53,000
Actuarial (70:15:15)	-$93,000	$65,100	$13,950	$13,950
Premium (20:60)		-$93,100	$23,275	$69,825
Total	$0	$0	$110,225	$136,775

From	Service Department Cost Allocation - Step Method (Allocation of Premium First)
	Service Department		Production Departments
	Actuarial	Premium rating	Advertising	Sales
Direct charges of department	$93,000	$28,000	$73,000	$53,000
Premium (20:20:60)	$5,600	-$28,000	$5,600	$16,800
Actuarial (1:1)	-$98,600		$49,300	$49,300
Total	$0	$0	$127,900	$119,100

Solution 3:

Service department cost = Direct Cost + Allocated Cost

Actuaria Department Cost = $93,000 + 20% of Premium Cost

= $93,000 + 0.20*Premium cost

Premium rating department Cost = $28,000 + 70% of actuarial cost

= $28,000 + 0.70 * actuarial cost

Premium rating department Cost = $28,000 + 0.70 ($93,000 + 0.20*Premium Cost)

Premium cost = $28,000 + $65,100 + 0.14*Premium cost

Personnel Cost = $93,100 / 0.86 = $108,256

Actuarial cost = $93,000 + $108,256*20% = $114651

From	Service Department Cost Allocation - Reciprocal Method
	Service Department		Production Departments
	Actuarial	Premium rating	Advertising	Sales
Direct charges of department	$93,000	$28,000	$73,000	$53,000
Actuarial (70:15:15)	-$114,651	$80,256	$17,198	$17,198
Premium (20:20:60)	$21,651	-$108,256	$21,651	$64,954
Total	$0	$0	$111,849	$135,151

Maintenance Cost = $12,000 + 0.13*$24,739 = $15,216