Case study cont’d
Bond has got two operating departments: production of handwritten cards and notes in the Manhattan facilities and manufacturing of robotic writing machines in Rhineback (NY). Moreover, Bond has five support departments, namely Cleaning, HR, General plant administration (GPA, which includes the development and maintenance of Bond’s mailing lists’ database and apps), Showroom and Warehouse. The monthly budgeted costs of each department are as follows:
Table 1 – Budgeted costs of the departments for the month of February 2023.
| Operating departments | Support departments | |||||
| Production
handwritten cards & notes |
Manufacturing of robotic machines | Cleaning | HR | GPA | Showroom | Warehouse |
| $34,700 | $48,900 | $12,500 | $10,000 | $26,090 | $1,640 | $2,670 |
The production of cards and notes is almost fully automated and requires 5,000 machine hrs per month. The manufacturing of robotic machines requires 15,000 machine hrs per month. The Warehouse activity depends on the requisitions of paper and ink (for handwritten cards and notes) or materials (for the robotic writing machines). The number of requisitions on February 2023 are estimated to be 2,000 and 1,000 for the two operating departments respectively. Other data regarding the departments are indicated below.
| Department | # Employees | Sqm floor space | Labour hrs | |
| Support | Cleaning | 5 | 100 | 750 |
| HR | 2 | 200 | 250 | |
| GPA | 35 | 700 | 3,500 | |
| Showroom | 10 | 400 | 1,000 | |
| Warehouse | 5 | 700 | 1,000 | |
| Operating | Production (cards & notes) | 50 | 3,000 | 8,000 |
| Manufacturing
(robotic machines) |
93 | 4,900 | 16,000 |
Required:
a) Choose the most appropriate allocation base for each support department and explain your choice.
b) Allocate support departments’ costs to operating departments using the direct method. Show your calculations. Calculate the rate per machine hr of the operating departments by dividing their total costs (after allocation of the support departments) and their respective machine hrs.
c) Allocate support departments’ costs to operating departments using the step- down method. Allocate the support departments’ costs in the same sequence as indicated in the case study. Show your calculations. Calculate the rate per machine hr of the operating departments by dividing their total costs (after allocation of the support departments) and their respective machine hrs.
d) Bond evaluates the performance of the operating department managers based on how well they managed their total costs (including the allocated costs from the support departments). You are the manager of the production of handwritten cards and notes. Which allocation method would you prefer from the results obtained in b) and c)? Provide an explanation, based on your figures.
Effective cost allocation is essential for businesses to accurately assess the profitability of their various departments and operations. This case study focuses on Bond Company, which operates in two distinct departments: production of handwritten cards and notes, and manufacturing robotic writing machines. The company also has five support departments: Cleaning, HR, General Plant Administration (GPA), Showroom, and Warehouse. The choice of cost allocation method and its impact on operating department managers’ performance evaluation are critical decisions for the company’s success.
The allocation base for each support department should ideally be closely related to the cost driver of that department’s expenses. In this case, the following allocation bases are recommended:
Cleaning: Sqm floor space is a relevant allocation base as the cleaning activity largely depends on the area that needs to be maintained.
HR: The number of employees is a suitable allocation base as HR activities often correlate with the size of the workforce.
GPA: Labour hours are an appropriate allocation base as the development and maintenance of databases and apps require labor-intensive efforts.
Showroom: Square meters of floor space is a relevant allocation base as the space directly affects maintenance and presentation efforts.
Warehouse: The number of requisitions is a fitting allocation base since the warehouse activity hinges on the materials required by operating departments.
The direct method allocates support department costs directly to operating departments without considering interactions between support departments. Using this method, the allocated costs for each operating department can be calculated as follows:
Production of handwritten cards and notes: Cleaning: ($12,500 / 2,500 hrs) * 8,000 hrs = $40,000 HR: ($10,000 / 250 hrs) * 8,000 hrs = $320,000 GPA: ($26,090 / 3,500 hrs) * 8,000 hrs = $60,380 Showroom: ($1,640 / 1,000 hrs) * 8,000 hrs = $13,120 Warehouse: ($2,670 / 1,000 requisitions) * 2,000 requisitions = $5,340
Manufacturing of robotic machines: Cleaning: ($12,500 / 2,500 hrs) * 16,000 hrs = $80,000 HR: ($10,000 / 250 hrs) * 16,000 hrs = $640,000 GPA: ($26,090 / 3,500 hrs) * 16,000 hrs = $120,760 Showroom: ($1,640 / 1,000 hrs) * 16,000 hrs = $26,240 Warehouse: ($2,670 / 1,000 requisitions) * 1,000 requisitions = $2,670
Rate per Machine Hour Calculation
Production of handwritten cards and notes: ($34,700 + $40,000 + $320,000 + $60,380 + $13,120 + $5,340) / 5,000 hrs = $87.308/machine hr
Manufacturing of robotic machines: ($48,900 + $80,000 + $640,000 + $120,760 + $26,240 + $2,670) / 15,000 hrs = $66.648/machine hr
The step-down method sequentially allocates costs from one support department to another based on a predetermined order. The calculated allocated costs can be distributed as follows:
Cleaning: Direct allocation to operating departments
HR: Add Cleaning costs, then allocate to operating departments
GPA: Add Cleaning and HR costs, then allocate to operating departments
Showroom: Add Cleaning, HR, and GPA costs, then allocate to operating departments
Warehouse: Add all support department costs and allocate to operating departments
As the manager of the production of handwritten cards and notes, I would prefer the step-down method for cost allocation. While the direct method is simpler, the step-down method better reflects the interdependencies among support departments. This method considers that support departments also consume resources from each other, leading to a more accurate cost allocation. This accuracy is important for assessing the true costs associated with each operating department’s activities.
Cost allocation methods have a substantial impact on departmental performance evaluation and decision-making within an organization. The choice of method should align with the organization’s goals and the complexity of its operations. In the case of Bond Company, the step-down method seems to provide a more accurate representation of the support departments’ costs and their impact on operating departments. Making informed decisions about allocation methods ensures fair evaluation of departmental performance and aids in optimizing resource allocation for the company’s growth and success.
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