Question

Exercise 7-28 Departmental Cost Allocation (LO 7-3, 7-5] 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: Actuarial From Actuarial Premium To Premium Rating 80 % Advertising Sales 10% 10% 1560 25 % The direct operating costs of the departments (including both variable and fixed costs) are: Actuarial Premium rating Advertising Sales $94,000 29,000 74,000 54,000 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. Complete this question by entering your answers in the tabs below.

Answer 1

1	Direct method:
	In this method cost allocated directly to two product departments and not to any support departments
						Actuarial	Premium rating	Advertising	Sales
	Total cost					94000	29000	74000	54000
	Cost of actuarial allocated at 10:10 or 1:1					-94000		47000	47000
								94000*(1/2)	94000*(1/2)
	Cost of premium rating allocated at 15:60 or 1:4						-29000	5800	23200
								29000*(1/5)	29000*(4/5)
	Total					0	0	126800	124200
2	Step-down method:
	In this method cost of Actuarial is allocated to premium rating,advertising and sales
	Then,cost of premium rating (Incl.cost allocated from actuarial) to product departments
						Actuarial	Premium rating	Advertising	Sales
	Total cost					94000	29000	74000	54000
	Cost of actuarial allocated at 80:10:10 or 8:1:1					-94000	75200	9400	9400
							94000*(8/10)	94000*(1/10)	94000*(1/10)
	Cost of premium rating allocated at 15:60 or 1:4						-104200	20840	83360
								104200*(1/5)	104200*(4/5)
	Total					0	0	104240	146760
3	Under reciprocal method it is assumed that cost from other service departments is included in the cost of individual service departments
	Total cost of a service department=Direct cost of the service department+Cost allocated to the service department
	Let's assume that cost of Actuarial=a
	Let's assume that cost of premium rating=p
	Ratio for allocation from premium rating to actuarial=25%=0.25
	a=94000+0.25p …………. 1
	Ratio for allocation from actuarial to premium rating=80%=0.80
	p=29000+0.80a …………. 2
	Apply 1 in 2
	p=29000+0.80*(94000+0.25p)
	p=29000+75000+0.20p
	p=104000+0.20p
	p-0.20p=104000
	0.80p=104000
	p=104000/0.80=$ 130000
	Apply p in 1
	a=94000+(0.25*130000)=$ 126500
	Allocation:
						Actuarial	Premium rating	Advertising	Sales
	Total cost					94000	29000	74000	54000
	Cost of actuarial allocated at 80:10:10 or 8:1:1					-126500	101200	12650	12650
							126500*(8/10)	126500*(1/10)	126500*(1/10)
	Cost of premium rating allocated at 25:15:60 or 5:3:12					32500	-130000	19500	78000
						130000*(5/20)		130000*(3/20)	130000*(12/20)
	Total					0	200	106150	144650
	$ 200 dufference is due to round off