Allocating Central Service Department Costs“I can’t believe it. We just went through a stu...

Allocating Central Service Department Costs

“I can’t believe it. We just went through a study showing how my department could save money by using the central maintenance department. But the first month using this department shows that my costs are up more than 20 percent.” Don Thompson, the general manager of the Delta Division of Ramo Products, had just received his monthly bill for maintenance services and he was obviously upset.

TABLE 1

TABLE 2

Before converting to the in-house department, the Delta Division had used outside suppliers for its maintenance services, at a cost of $15,000 per month. An internal task force, investigating the use of outside services that were also available internally, had found that all the maintenance needs of the Delta Division could be handled internally. At present, the maintenance department had unused capacity, and the additional services required by Delta could be supplied at an incremental cost of $10,000. After some assurance that his division’s maintenance services could be supplied at this lower incremental cost, Don Thompson agreed to convert from external to internal supply of services.

After receiving a monthly bill for more than $18,000 for maintenance, Thompson demanded an explanation. Phil Johnson, the manager of the maintenance department, provided the following data. Table 1 shows the allocation of the monthly maintenance department costs of $120,000 to the three other divisions of Ramo Products, before handling Delta’s requirements: As Johnson explained, “We have to charge out the costs of our division in some equitable manner. We’ve decided that an allocation based on hours supplied is as good as any.” Johnson then showed (see Table 2) how the allocation to Delta was derived on the basis of incremental costs of $10,000 and the 200 maintenance hours provided to Delta.

Required

(1) Comment on the method used by Johnson to charge for the use of maintenance in Ramo Products. Why does this method cause Delia’s charges to increase from $15,000 to $18,600 per month?

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(2) Suggest alternative methods for charging for the use of this internal service department that would provide better incentives for use of this department.