Problem 5 - Accounting

Question

In divisional income statements prepared for Black Top Paving Company, the Payroll Department costs are charged back to user divisions on the basis of the number of payroll checks, and the Purchasing Department costs are charged back on the basis of the number of purchase requisitions. The Payroll Department had expenses of \(24,450, and the Purchasing Department had expenses of \)10,400 for the year. The following annual data for Residential, Commercial, and Highway Divisions were obtained from corporate records: \begin{tabular}{lrrr} & Residential & Commercial & Highway \\ \hline Sales & \(\$ 400,000\) & \(\$ 500,000\) & \(\$ 1,000,000\) \\ Number of employees: & & & \\ Weekly payroll (52 weeks per year) & 80 & 40 & 60 \\ Monthly payroll & 14 & 11 & 10 \\ Number of purchase requisitions per year & 1,000 & 850 & 750 \end{tabular} a. Determine the annual amount of payroll and purchasing costs charged back to the Residential, Commercial, and Highway Divisions from payroll and purchasing services. b. Why does the Residential Division have a larger service department charge than the other two divisions, even though its sales are lower?

Step-by-Step Solution

Answer

Residential Division has higher costs due to more payroll check usage, unrelated to sales.

Step 1: Calculate Total Payroll Checks

First, we need to determine the total number of payroll checks issued annually for each division. For weekly payroll employees, multiply the number of employees by 52. For monthly payroll employees, multiply the number of employees by 12. Thus, for Residential: \[80 \times 52 + 14 \times 12 = 4,160 + 168 = 4,328\] For Commercial: \[40 \times 52 + 11 \times 12 = 2,080 + 132 = 2,212\] For Highway: \[60 \times 52 + 10 \times 12 = 3,120 + 120 = 3,240\] So, the payroll checks total are: Residential: 4,328, Commercial: 2,212, Highway: 3,240.

Step 2: Allocate Payroll Department Costs

Next, allocate the Payroll Department's expenses (\\(24,450) based on the number of payroll checks. First, calculate the total number of payroll checks: \[4,328 + 2,212 + 3,240 = 9,780\] Now, calculate the cost per check: \[\frac{24,450}{9,780} \approx \\)2.50\] Multiply checked numbers by the cost per check for each division:- Residential: \[4,328 \times 2.50 = \\(10,820\]- Commercial: \[2,212 \times 2.50 = \\)5,530\]- Highway: \[3,240 \times 2.50 = \$8,100\]

Step 3: Allocate Purchasing Department Costs

Now we allocate the Purchasing Department's expenses (\\(10,400) based on the number of purchase requisitions. First, determine the total number of requisitions: \[1,000 + 850 + 750 = 2,600\] Then, calculate the cost per requisition: \[\frac{10,400}{2,600} = \\)4.00\] Multiply the number of requisitions by the cost per requisition for each division:- Residential: \[1,000 \times 4.00 = \\(4,000\]- Commercial: \[850 \times 4.00 = \\)3,400\]- Highway: \[750 \times 4.00 = \$3,000\]

Step 4: Calculate Total Allocated Costs per Division

Finally, sum the allocated payroll and purchasing costs for each division:- Residential: \[10,820 + 4,000 = \\(14,820\]- Commercial: \[5,530 + 3,400 = \\)8,930\]- Highway: \[8,100 + 3,000 = \$11,100\]

Step 5: Analyze Why Residential Division Has Higher Costs

The Residential Division has higher service department charges because it processes a higher volume of payroll checks (4,328) than the other two divisions, even though it has the lowest sales figures. The costs are allocated based on service use (number of checks and requisitions), not sales revenue.

Key Concepts

Divisional Income Statements

Understanding Divisional Income Statements can simplify financial analysis for companies with multiple divisions. These statements provide an overview of each division's financial performance, giving insights into their revenues, costs, and overall profitability. By breaking down company finances into individual divisions, management can assess which parts of the business are performing well and which may need improvement.
Each division in a company generates its own revenues and incurs its own expenses, but some costs are shared among all divisions. For instance, service departments like payroll and purchasing might serve every division, and hence their costs need to be allocated appropriately.
In the analyzed exercise, each division's share of these common costs is calculated based on their usage of the service, not their revenue. This helps ensure that costs reflect actual resource consumption, making the income statement for each division more accurate.

Service Department Charges

Service Department Charges reflect the costs of internal support provided to various divisions within a company. This includes costs from departments like payroll, IT, or purchasing, which do not directly generate revenue but are essential for the company’s operations.
In the given problem, the Payroll Department's and Purchasing Department's charges are allocated based on the number of payroll checks and purchase requisitions, respectively, by each division during the year. This ensures the cost reflects the actual usage of services by each division.
For instance, the Residential Division had more payroll checks processed than the other divisions, which led to a greater charge from the Payroll Department. Understanding how these charges are applied helps divisions manage their operations within budgetary constraints, optimizing resource allocation.

Direct Cost Allocation Method

The Direct Cost Allocation Method is a straightforward approach for distributing service department costs to divisions based on pre-determined usage metrics. This is ideal for companies seeking clarity in how shared expenses impact each division.
In the provided exercise, costs from the Payroll and Purchasing Departments are allocated using the Direct Cost Allocation Method. The key here is choosing the right base for allocation. The payroll costs were allocated based on the number of payroll checks, while purchasing costs were allocated based on purchase requisitions.
It’s a systematic process that relates expense proportions directly with service usage, enhancing transparency and accounting accuracy. Adopting such methods ensures that divisions are responsibly charged for the resources they utilize, facilitating better financial planning and accountability.