Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 51

Reciprocal Cost Allocation—Outsourcing a Service Department

Refer to the facts in Problem 11-46. The cost accountant at Manzano Bank estimates that the cost

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structures in their departments are as follows:

	Processing	Administration	Maintenance	Branches	Electronic
Variable costs	$ 80,000	$240,000	$180,000	$2,500,000	$1,200,000
Fixed costs	40,000	510,000	150,000	3,500,000	1,050,000
Total costs	$120,000	$750,000	$330,000	$6,000,000	$2,250,000
Avoidable fixed costs	$ 10,000	$403,000	$120,000	$2,112,500	$ 910,000

Required

a.If Manzano outsources the Processing Department, what is the maximum they can pay an outside vendor without increasing total costs?

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b.If Manzano outsources the Administration Department, what is the maximum they can pay an outside vendor without increasing total costs?

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c.If Manzano outsources the Maintenance Department, what is the maximum they can pay an outside vendor without increasing total costs?

Step 1 of 4

Cost accounting system

This is a system designed for inhouse or internal managers and their decision making. Cost accounting information is not needed for comparison with other companies. This information is commonly used in financial accounting also, but it is primarily used by company managers for their decision making. It is important that cost accounting information is relevant for the decision making of the manager.

Cost allocation of service departments

Service departments like human resource, administration, accounts, IT etc. render their services to other user departments which may include production or other service departments also. The costs of these service departments also need to be allocated among other user departments for product and departmental costing purposes. There are different methods used for service costs allocation like direct method, step method and reciprocal method.