Problem:
Reciprocal Cost Allocation-Outsourcing a Service Department
Refer to the facts in Problem. Cost records obtained from Farmington Components show the following cost structure in their departments:
|
|
Engineering
|
Administration
|
Maintenance
|
Fabrication
|
Assembly
|
|
Variable costs
|
$100,000
|
$320,000
|
$130,000
|
$700,000
|
$380,000
|
|
Fixed costs
|
100,000
|
630,000
|
120,000
|
1,050,000
|
120,000
|
|
Total costs
|
$200,000
|
$950,000
|
$250,000
|
$1,750,000
|
$500,000
|
|
Avoidable
|
|
|
|
|
|
|
fixed costs
|
$ 70,000
|
$400,000
|
$ 70,000
|
$ 912,500
|
$ 75,000
|
Required
a. If Farmington outsources the Engineering Department, what is the maximum they can pay an outside vendor without increasing total costs?
b. If Farmington outsources the Administration Department, what is the maximum they can pay an outside vendor without increasing total costs?
c. If Farmington outsources the Maintenance Department, what is the maximum they can pay an outside vendor without increasing total costs?
Cost Allocation: Step and Reciprocal Methods
Farmington Components has two production departments (Fabrication and Assembly) and three service departments (Engineering, Administration, and Maintenance). During July, the following costs and service department usage ratios were recorded:
|
Supplying
|
|
Using Department
|
|
|
|
|
|
|
|
|
Department
|
Engineering
|
Administration
|
Maintenance
|
Fabrication
|
Assembly
|
|
Engineering
|
-0-
|
50%
|
-0-
|
10%
|
40%
|
|
Administration
|
20%
|
-0-
|
10%
|
50%
|
20%
|
|
Maintenance
|
-0-
|
20%
|
-0-
|
30%
|
50%
|
|
Direct cost
|
$200,000
|
$950,000
|
$250,000
|
$1,750,000
|
$500,000
|
Required
Allocate the service department costs to the two operating departments using the reciprocal method.