Question

Biotech, Inc., recently began providing cafeteria services to its employees. Because revenue from the sale of food at the cafeteria does not fully cover cafeteria expenses, Biotech must pay for the shortfall. These costs are allocated to production departments based on employee usage. That is, the company tracks which employees use the cafeteria and allocates costs to production departments accordingly.

Sarah Kolster, manager of the quality testing department, is not happy with receiving cafeteria cost allocations. She is evaluated based on meeting a cost budget established at the beginning of the fiscal year, which does not include the cafeteria allocation, and she clearly has an incentive to minimize costs.

When Sarah met with the company’s accountant, Dan, regarding this issue, she said, “Dan, I like the idea of providing cafeteria service to our employees, but the costs allocated to my department are killing my budget. Last month alone, I was allocated $3,000 in costs related to the new cafeteria. I have no choice but to require my employees to go elsewhere for food.”

Dan responded, “I understand your concern, Sarah. Management’s intent was to provide a service to our employees that would improve productivity and reward employees for their hard work. If you tell your employees to stop using the cafeteria, more costs will be allocated to other departments, and the other departments might also stop using the cafeteria. My belief is that the cafeteria will be self-sufficient within a year if more employees are encouraged to use it. This translates into no more cost allocations to departments within a year. I’ll discuss your concerns with top management later this week.”

Required:

a. Why does Biotech, Inc., allocate cafeteria costs to departments?

b. What recommendations would you make to top management regarding the way cafeteria costs are allocated to departments?

Answer 1

a. Biotech Inc. Allocates Cafeteria costs to departments since it a service cost. The cost of servicing other departments should be allocated to the department consuming the services. Cafeteria is a servicing department and other departments like Accounts, Quality, Production, Engineering, Maintenance, etc are the receiving departments who get cost allocated based on the service usage. The cost allocation is part of product costing where by ultimately all service department costs should get allocated to production department based on appropriate cost drivers.

b. It seems the management is using the direct method of allocating overheads to production department. The management should use step method or reciprocal method of cost allocation to department rather than using direct method of cost allocation. Reciprocal method considers the mutual service rendered by one service department to one another. The cost driver of number of employees using the cafeteria service is appropriate for allocation of Cafeteria Department costs.