Chapter Nine- Activity-Based Costing

Chapter Eleven- Service Department and Joint Cost Allocation
Study Tips
• Service department costs increase the cost of the product and these costs should be attached
to the products.
• Different allocation methods are based on different assumptions: (1) direct allocation, no
service department provides service to any other service department; (2) step allocation,
service departments can provide service to other service departments but cannot, at the same
time, receive service from other service departments; (3) reciprocal method, full reciprocity
between service departments.
• Judgments must be made considering the difference between the necessity of joint cost
allocation for financial statements and the irrelevancy of such allocation for decision making.
Summary
Continuing the discussion of product cost determination, first there is a focus on service
departments, why and how these costs relate to production. The remainder of the chapter is
devoted to discussion of joint cost allocation.
Service Department Cost Allocation
The primary function of a service department is to provide service to other departments.
Examples of a service department include a cafeteria, the buildings and grounds group, the
computer center, and human resources. These service departments provide service to the
producing departments (e.g., stamping, assembly, or finishing) and to non-producing
departments (e.g., all the other service departments). The service department is a cost used by the
production department; all costs of production should be attached to the products.
Because there is usually no direct, traceable relationship to the products being manufactured, the
service cost attachment process must be an indirect one. Relevant service department costs are
allocated to the producing departments, which increases that department's overhead. This in turn
will increase the producing department's overhead rate which, when applied to the products, will
attach a portion of the service department's costs to each product.
Assume that Kennesaw Manufacturing Company has two production departments, Assembly and
Finishing; there are two service departments, the cafeteria and the buildings and grounds.
Job #62 requires 400 machine hours in Assembly and 100 direct labor hours in Finishing. The
amount of overhead applied to Job #62 would be $1,600 (400 x $3 + 100 x $4).
4