In effect, producing departments cause support activities; therefore, the costs of support departments are also caused by the activities of the producing departments. Causal factors are variables or activities within a producing department that provoke the incurrence of support costs. In choosing a basis for allocating support department costs, every effort should be made to identify appropriate causal factors (activity drivers). Using causal factors results in product costs being more accurate. Furthermore, if the causal factors are known, managers are more able to control the consumption of services.
To illustrate the types of causal factors, or activity drivers, that can be used, consider the following three support departments: power, personnel, and materials handling. For power costs, a logical allocation base is kilowatt-hours, which can be measured by separate meters for each department. If separate meters do not exist, perhaps machine hours used by each department would provide a good proxy, or a means of approximating power usage. For personnel costs, both the number of producing department employees and the labor turnover (e.g., number of new hires) are possible activity drivers. For materials handling, the number of material moves, the hours of materials handling used, and the quantity of material moved are all possible activity drivers. Exhibit 7-3 lists some possible activity drivers that can be used to allocate support department costs. When competing activity drivers exist, managers need to assess which factor provides the most convincing relationship.
To illustrate the types of causal factors, or activity drivers, that can be used, consider the following three support departments: power, personnel, and materials handling. For power costs, a logical allocation base is kilowatt-hours, which can be measured by separate meters for each department. If separate meters do not exist, perhaps machine hours used by each department would provide a good proxy, or a means of approximating power usage. For personnel costs, both the number of producing department employees and the labor turnover (e.g., number of new hires) are possible activity drivers. For materials handling, the number of material moves, the hours of materials handling used, and the quantity of material moved are all possible activity drivers. Exhibit 7-3 lists some possible activity drivers that can be used to allocate support department costs. When competing activity drivers exist, managers need to assess which factor provides the most convincing relationship.
While the use of a causal factor to allocate common cost is the best solution, sometimes an easily measured causal factor cannot be found. In that case, the accountant looks for a good proxy. For example, the common cost of plant depreciation may be allocated to producing departments on the basis of square footage. Though square footage does not cause depreciation, it can be argued that the number of square feet a department occupies is a good proxy for the services provided to it by the factory building. The choice of a good proxy to guide allocation is dependent upon the company’s objectives for allocation.Also read objectives of allocation
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