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QUESTION 5 – Service department cost allocation (13 marks) J & J Products sources locally grown fruits to produce their famous jams and juices
QUESTION 5 – Service department cost allocation (13 marks)
J & J Products sources locally grown fruits to produce their famous jams and juices. The company’s controller assesses the manager of each department on their ability to control costs. As such, he wants to properly allocate the cost of their 2 major service departments; Janitorial and Human resources to their two production plants, Jam, and Juice.
It should be noted that Janitorial and Human resources also provide services to each other. Janitorial costs are allocated by square metres and Human resources costs are allocated by number of employees. Department costs, along with the square metres each department occupies and the number of employees that worked during August are provided below.
|
August Data |
Janitorial |
Human resources |
Jam production |
Juice production |
|
Budgeted costs |
$8,225 |
$17,940 |
$31,720 |
$52,400 |
|
Actual costs |
$9,140 |
$18,330 |
$28,990 |
$55,250 |
|
Number of employees |
6 |
3 |
14 |
20 |
|
Square metres |
3,600 |
1,590 |
5,406 |
8,904 |
Required:
Allocate the costs of the service departments to the operating department. The resulting schedules will include the total cost of operating the Jam production and Juice production departments for August using the appropriate figures.
Apply the costs using the following methods:
- Allocate service department costs using the direct method. (3 marks)
(continued on next page) - Allocate service department costs using the reciprocal method. (5 marks)
The owner of J & J Products, Quy Vo would like your recommendation on whether they should use the Direct or Reciprocal method of support department cost allocation. Back up your recommendation with a discussion of the advantages and disadvantages of both methods and the reasons for your recommendation. Remember to use pertinent figures from your quantitative analysis
Expert Solution
| Allocation of Service Department Costs to Production Departments using Direct method: | ||||||
| Service Departments | Production Departments | |||||
| Cost Driver | Ratio | Janitorial | Human Resources | Jan Production | Juice Production | |
| Department Direct Costs | $9,140 | $18,330 | $28,990 | $55,250 | ||
| Allocation of Janitorial Department Costs | Square Metres | 5406:8904 | ($9,140) | $3,453 | $5,687.11 | |
| Allocation of Human Resources Department Costs | No of employees | 14:20 | ($18,330) | $7,548 | $10,782 | |
| Total Costs | $0 | $0 | $39,991 | $71,719 |
Allocation of Service Department Costs to Production Departments using the reciprocal method:
Let total costs of Janitorial Department after allocating Human Resources Department costs be x
and total costs of Human Resources Department after allocating Janitorial Department Costs be y
Janitorial Department Costs allocated to Human Resources Department (Based on Square metres)
= x * 1,590 / (1,590+5,406+8,904)
= x * 1,590/15,900
= 0.1x
Human Resources Costs allocated to Janitorial Department (Based on No. of employees)
= y * 6 / (6+14+20)
= y * 6/40
= 0.15y
Total Costs of Janitorial Department = Costs of Janitorial Department + Costs of Human Resources Department allocated
x = $9,140 + 0.15y
Total Costs of Human Resouces Department = Costs of Human Resources Department + Costs of Janitorial Department allocated
y = $18,330 + 0.1x
Solving the equations:
y = $18,330 + 0.1 ($9,140 + 0.15y)
y = $18,330 + $914 + 0.015y
0.985y = $19,244
y = $19,244 / 0.985
y = $19,537.05
x = $9,140 + 0.15y
x = $9,140 + 0.15 ($19,537)
x = $9,140 + $2930.55
x = $12,070.55
Total Costs of Janitorial Department = $12,071
Total Costs of Human Resources Department = $19,537
| Allocation of Service Department Costs to Production Departments using Reciprocal method: | ||||||
| Service Departments | Production Departments | |||||
| Cost Driver | Ratio | Janitorial | Human Resources | Jan Production | Juice Production | |
| Department Direct Costs | $9,140 | $18,330 | $28,990 | $55,250 | ||
| Allocation of Janitorial Department Costs | Square Metres | 1590:5406:8904 | ($12,071) | $1,207 | $4,104 | $6,759.76 |
| Allocation of Human Resources Department Costs | No of employees | 6:14:20 | $2,931 | ($19,537) | $6,838 | $9,769 |
| Total Costs | $0 | $0 | $39,932 | $71,778 |
It is recommended to use Reciprocal method rather than the direct method of allocating service department costs to production department costs.
Advantage of Reciprocal Method is that it considers the services provided by one service department to other service department also. Disadvantage is that it is a complex method of calculation.
Advantage of Direct Method is that it is very simple easy method of calculation. Disadvantage is that it ignores the inter-Service Departments Services.
In case of Direct method, service cost of $1,207 provided by the Janitorial Department to the Human Resouces Department and the service Cost of $2,931 provided by the Human Resouces Department to the Janitorial Department are ignored. Hence the total costs of Production Departments arrived by using Direct Method is not accurate.
Since Reciprocal Method considers the inter-Service Department Costs, it is more accurate and highly recommended.
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