Question

Support activity cost allocation

Jake’s Gems mines and produces diamonds, rubies, and other gems. The gems are produced by way of the Mining and Cutting activities. These production activities are supported by the Maintenance and Security activities. Security costs are allocated to the production activities based on asset value. Maintenance costs are normally allocated based on machine hours. However, Maintenance costs typically correlate more with the number of service calls. Information regarding the activities is provided in the following table:

	Maintenance	Security	Mining	Cutting
Number of service calls	17	20	60	20
Machine hours	89	88	182	176
Asset value	$200,000	$80,000	$300,000	$300,000
Department cost	$25,000	$42,500	$160,000	$95,000

1. Is the process of allocating maintenance costs based on machine hours correct? Identify the measure than can possibly be used to allocate the maintenance costs.

No

Measures that can possibly be used to allocate the maintenance costs.

a. Number of service calls

b. Asset value

c. Department cost

d. None of the above

a

2. Based on your response to part (1), determine the total costs allocated from each support activity to the other activities using the reciprocal services method and the most appropriate cost driver for Maintenance.

	Maintenance Department	Security Department	Mining Department	Cutting Department
Maintenance cost allocation		$	$	$
Security cost allocation	$		$	$
Production activities total costs			$	$

3. Assume Jake’s Gems is considering cutting costs by switching to a simpler support activity cost allocation method. Determine the total costs allocated from each support activity to the other activities.

Particulars	Mining Department	Cutting Department
Maintenance cost	$	$
Security cost	$	$
Production activities total cost	$	$

Answer 1

ANS 1) Jake's Gems mines had no the process of allocation maintenance cost on the basis of machine hours is incorrect. Because it is mentioned that maintenance cost correlates to service calls so it should be allocated on the basis of service calls. Reciprocal Allocation Method Maintenance Security Mining Cutting Number of Service calls 20.00 60.00 20.00 % of Number of Service calls 20.00% 60.00% 20.00% Asset Value 200,000.00 3,00,000.00 3,00,000.00 % of Asset Value 25.00% 37.50% 37.50% Department cost 25,000.00 42,500.00 1,60,000.00 95,000.00 Let Overhead cost of Maintenance department is $ X and Overhead cost of Security is $ Y So, X= 25000+ 25% of Y Equation 1 Y=42500+ 20% of X Equation 2 Or, X= 25000+ 0.25Y Y= 42500+ 0.20 Total 100.00 100% 800,000.00 100% 322,500.00

Working note: 1 Substituting the value of X in equation 2: Y = 42500 +0.20(25,000 +0.25Y) Y = 42500 +5,000+.05Y Y-0.05Y = 42,500 +5,000 0.95Y = 47,500 Y = 47,500/.95 Y = $50,000 Working note: 1 Substituting the value of Yin equation 1: So, X= 25000+ 25% of Y So, X= 25000+ 25% of 50,000 So, X= 25000+ 12,500 X= $ 37,500

Reciprocal Allocation Method Number of Service calls % of Number of Service calls Asset Value % of Asset Value Department cost Allocation Maintenance (on the basis of % of Service calls) Security (on the basis of % of Asset Value) Production activities total cost Allocation Summary Maintenance Security 20.00 20.00% 200,000.00 25.00% 25,000.00 42,500.00 Mining | Cutting | 60.00 20.00 60.00% 20.00% 3,00,000.00 3,00,000.00 37.50% 37.50% 1,60,000.00 95,000.00 Total 100.00 100% 800,000.00 100% 322,500.00 (37,500.00) 7,500.00 22,500.00 7,500.00 12,500.00 (50,000.00) 18,750.00 18,750.00 2,01,250.00 1,21,250.00 322,500.00 Allocation Summary Maintenance Security Direct Method Number of Service calls % of Number of Service calls Asset Value % of Asset Value Department cost Allocation Maintenance (on the basis of % of Service calls) Security (on the basis of % of Asset Value) Production activities total cost Mining Cutting 60.00 20.00 75.00% 25.00% 3,00,000.00 3,00,000.00 50.00% 50.00% 1,60,000.00 95,000.00 Total 80.00 100% 600,000.00 100% 322,500.00 25,000.00 42,500.00 (25,000.00) 18,750.00 6,250.00 (42,500.00) - 21,250.00 21,250.00 2,00,000.00 1,22,500.00 322,500.00 Yes it is viable to choose Direct method of cost Allocation. Because Option b. The difference between Direct cost allocation method and reciprocal method is minimal and the direct method is easier.