Management and Allocation of Support Service Costs

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Introduction

All types of organizations, regardless of the form of business activity that they are engaged in, do incur costs. Businesses, non profit organizations and other organizations such as governmental agencies do incur costs as part of their operations. The term cost can be conceptualized variously depending on the orientation and context of the scholar. On a broader sense, it is taken as the sacrifice that is made in the process of undertaking an economic activity. In order to attain their objectives, all organizations must undertake in economic activities, and that is the reason why they do incur costs. The activities include consumption, exchange of goods and services, production of goods and services among others.

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Support services are some of the economic activities that are economic in nature and which add up to a cost on the part of the organization. Support services are those functions that are undertaken to enable the successful completion of a task, a process, a program or a project by the organization. Such are labor services, overhead costs, production services and others.

Controlling costs and competitive pricing are some of the expectations that the organization has from their accountants and financial staff. To achieve this, the accountants have to come up with strategies examine and manage the allocation of support service costs in various facets o the organizations. This is done by following guidelines and methods that are known to effectively manage and allocate these costs.

Objectives of the Study

Throughout this study, he author will be guided by one major objective. This is summarizing the management and allocation of support service costs in organizations. To achieve this, the writer will be guided by a set of specific objectives. It is by addressing these specific objectives that the writer will have effectively addressed the major objective. The specific objectives are as listed below:

  1. importance of management and allocation of support service costs
  2. guidelines to be followed in the process of managing and allocating support service costs
  3. ethical considerations in management and allocation of support service costs
  4. methods of managing and allocating support service costs

Importance and Significance of Management and Allocation of Support Service Costs

To cost accountants and organizations in general, the importance and significance of managing and allocating the costs of support services can not be down played. Organizations exist in a very competitive environment in contemporary society. This being the case, it becomes paramount to come up with strategies that can be used to cut down on operation costs to improve the competitive ability of the business (Hansen, Mowen & Guan, 2008). This can be achieved by managing the amount of money that is spent on various aspects of the organization’s operations. Support service is such one operation that must have their expenditure scrutinized. Effective allocation of costs to these services ensures that resources are effectively utilized, eliminating wastage and unnecessary expenditures. For example, when costing for these services, an accountant may realize that a certain department has been engaging in activities that are not beneficial to the overall performance of the organization. These activities, despite their lack of value to the business, do involve expenditure. For effective running of the firm, the activities are not funded any more.

Businesses find it important to identify the long run costs that are associated with the production of each item, may it be a commodity or service (Killough & Brown, 2008). This is to ensure that pricing and other activities are performed in a competitive manner. This fete can be achieved by the management and allocation of costs to these activities, including those of support service nature. Killough and Brown opine that with the application of accounting software and programs such as Lotus 1 2 3, accountants can, with a reliable measure of accuracy, allocate costs properly to these activities (Killough & Brown, 2008). This makes it possible, subsequently, to determine the amount of resources that have been dedicated to the process of producing a certain service or commodity.

Guidelines in Managing and Allocating Support Service Costs

Hogan and Mrashall hold that financial managers are faced with a battery of challenges as they go about accounting for various service costs in the organization (Hogan & Mrashall, 2009). These challenges include hidden costs, confusion between actual and budgetary expenditure, allegations of favoring certain departments among others. However, there are guidelines that can be followed to make sure that the task of the financial managers is not complicated unnecessarily.

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One of the guidelines to be followed is to separate support service costs within various departments in the organizations into fixed and variable components (Stinson, 2008). This separation, cautions Hogan and Mrashall, should be carried out on a budgeted cost basis (Hogan & Mrashall, 2009). The aim of this is to make sure that production of support services is carried out efficiently so that the firm can derive maximum benefits from them. The separation also ensures that support services are utilized well by recognizing the short term and long term facets of two seemingly different types of costs. Using budgeted allocation has some benefits over utilizing actual allocation method. This is because, holds Stinson (2008), it “places the responsibility in the support service areas, from where the costs first arose” (28).

The second guideline to be followed is the allocation of separated costs by the use of distinct criteria based on the realization of the differing nature of the costs’ sources (Collins, 2007). The following section will examine the two guidelines (separation of service costs and allocation of the same) in detail.

Separation of Support Service Costs

This is recognized as the most complicated part in the management and allocation of support service costs (Blocher, Chen & Lin, 2009). After the fixed and variable support services have been identified and separated, budgets are then created for each category. This makes the process all the more complicated. This calls for the development of what Hogan and Mrashall (2009) refer to as a flexible budget for each of the support service outputs. This will indicate the interplay between the cost o the out put and the processes of the service department that go into production of the same (Hogan & Mrashall, 2009).

Separation of these costs is further muddled by the myriad of support service activities found in a conventional organization. This is for example administration services, accounting, acquisition of raw materials, wages and salaries and among others (Klein & Brown, 2008). To come up with a coherent budget relationship, simplification is called for, and cost benefit considerations have to be incorporated in the process. Hansen, Mowen and Guan opine that a surrogate representing service can be created as a measure to attain this simplification (Hansen et al, 2008). This can be for example the aggregate number of units that are produced by a plant or any other variable for which data can easily be availed (Kaplan & Atkinson, 2007). But this surrogate has one major shortcoming; it down plays the differing nature of effects accrued from cost generating activities in each of these service areas (Kaplan & Atkinson, 2007). Assumption, which may be fallacious, is made to the effect that the level and cost of these activities display a uniform and proportionate variation with the number of units produced.

Allocation of the Separated Costs

As earlier indicated, different criteria are used to allocate the costs that have being separated. The criteria selected have to take into account the fact that costs are accrued by the business for a number of differing reasons. For example, fixed services costs are incurred by the provision of support services in the long run (Kaplan & Atkinson, 2007). This is as opposed to variable service costs which arise from satisfaction of short term demand (Kaplan & Atkinson, 2007).

Planned long term service use is considered when allocating fixed costs. On the other hand, the financial manager will allocate variable costs depending on anticipated short term use and demand (Hansen et al, 2008). In the long run, fixed cost allocations are more or less stable from one financial year to the other. The only factor that may make it vary is shifting of service capacity of the business (Hansen et al, 2008). Contrast this with variable cost allocations. The latter fluctuate from one financial year to the other, depending on corresponding fluctuations in the demand and use of service within the same period.

Killough and Brown (2008) are of the view that financial managers should ideally take into account the above two guidelines when managing and allocating support service costs. Disregarding them may lead to complications and problems for the manager. A case in point is the allocation of actual as opposed to budgeted costs for a certain support service. This may encourage inefficiencies in the organization, for activities and services that are not beneficial to the organization are “costed” (Hogan & Mrashall, 2009). This will result in undermined competitive ability of the firm.

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On the other hand, uniform allocation of fixed and variable costs will also lead to problems for the finance manager. It will make the whole process of managing and allocating costs appear arbitrary to supervisors and other departmental managers (Collins, 2007). Successful implementation and control of operation within the organization will then be hampered.

Ethical Considerations in Management and Allocation of Support Service Costs

Like other business processes, ethical considerations are made when allocating and managing support service costs. Klein and Brown (2008) give the case of a government contract that is offered to a private contractor. The government offers the contract to the private contractor on a cost plus basis. This means that the government reimburses to the contractor all the costs that are incurred during the contract on top of a percentage of the profit.

A financial manager with the private contractor may come up with a formula that allocates to the government contracts more indirect costs than in other projects (Klein & Brown, 2008). This can be done by the manager inflating the costs allocated to the support service facet of the project. This, according to Kaplan and Atkinson (2007) comprises unethical conduct on the part of the financial manager.

When managing and allocating costs for support service, the financial manager should ensure that ethical standards that are established within the field are adhered to. These include allocating the costs, as earlier stated, based on budgetary expectation as opposed to actual expenditure. Deliberate manipulation of figures, for example in the case of the above private contractor, should be avoided.

Methods of Managing and Allocating of Support Service Costs

Blocher, Chen and Lin (2009) are of the opinion that there are three basic methods of allocating support service costs, especially to production departments or not for profit programs in a non governmental organization. These are the direct method, the step method and the reciprocal method. The method that is preferred by the financial manager is informed by the relationship between the costs area and the demand that is exerted by other areas on it (Collins, 2007). The manager takes into consideration cause and effect and the benefits received aspects when making decisions as to the method to use in the allocation.

Direct Method of Management and Allocation

In this method, the manager takes into account the extent to which the production department uses or plans to use the services of the service department (Hansen et al, 2008). This is when the manager intends to allocate the service department’s costs to the production department within the same firm. For example, how much labor is expected to be used by the assembly line in a given period?

The extent of use or demand of a support service by the production department is expressed in terms of a percentage. This is done by calculating the amount of services that are actually availed by the service department to all the other production departments or alternatively, the quantity of services that support service department is able to provide under normal circumstances or when operating at full capacity (Stinson, 2008). The two forms of costing identified earlier-the fixed and variable costing-can be allocated on a separate basis by the financial manager (Stinson, 2008). This, according to Hogan and Mrashall (2009) will result in a dual allocation process.

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Step Method of Allocation

The manager takes in to account reciprocity of services to some extent when allocating and managing support services cost in this method. This method is also referred to as sequential method. The manager starts by allocating the service department that is deemed to provide the highest amount of service to the other service departments (Hogan & Mrashall, 2009). This is followed by the other service department in the order of the quantity of services that they provide to other departments. A challenge is presented to the manager when it is revealed that two departments offer the same quantity of services to others. In this case, the actual amount of money that is spent by the departments is used to differentiate them. The department that uses the most amount of money takes precedence (Killough & Brown, 2008). When a support service department has been allocated cost, the manager does not take it into consideration when the remaining departments are been allocated (Killough & Brown, 2008). For example, after the human resource department has been allocated cost, it is ignored in subsequent allocations, when other departments like logistics and information technology are been considered for allocation.

Reciprocal Method of Allocation of Costs

The manager takes into account all the reciprocal services when allocating costs using this method. This is achieved by coming up with a set of simultaneous equations, where every support service department is allocated its own equation. the solving of the simultaneous equation gives the manager the reciprocal or artificial cost (Blocher et al, 2009). This is then allocated to all the other departments within the organization (both support service and production departments). This is done in accordance with the original percentage usages.

Conclusion

Management and allocation of support service costs is identified as one of the most important activities to be undertaken by any financial manager. It is useful in identifying the actual cost that the firm is incurring from support services and how these can be allocated for efficiency. The end result is total improvement of thee business as far as its competition capability is concerned. There are two guidelines that are to bee followed in carrying out this process. The first is the separation of fixed and variable costs, and allocation of costs to each using a set of different criteria. It is also important for the financial manager to take into account ethical consideration when managing and allocating costs to support service activities. This will help in making the process more professional and beneficial to the institution. There are generally three methods that are followed when allocating costs to the support service department in a firm. These are the direct, step and reciprocal methods.

References

Blocher, E. J., Chen, K. H., & Lin, T. W. (2009). Cost management: A strategic emphasis. 3rd ed. New York: McGraw-Hill, 376-398.

Collins, D. (2007). “A general matrix model of support department cost allocation methods”. The Journal of Applied Business Research, 19(1), 2-5.

Hansen, D. R., Mowen, M. M., & Guan, L. (2008). Cost management: Accounting and control. New York: Cengage Books, 215.

Kaplan, R. S., & Atkinson, A. A. (2007). Advanced management accounting. 3rd ed. New Jersey: Prentice Hall, 92-97.

Killough, L. N., & Brown, R. M. (2008). “How PCs can solve thee cost allocation problem: Service department costs now can be allocated with ease.” Management Accounting, 23(34), 19-26.

Klein, L. A., & Brown, C. (2008). “Allocation of service and administrative costs.” National Association of Accountants, 12(3), 34.

Hogan, A. J., & Mrashall, R. (2009). “How to improve allocation of support services costs”. Healthcare Financial Management, 15(5), 29-38.

Stinson, J. B. (2008). “Cost allocation-From the simple to thee sublime.” Management Accounting Quarterly, Fall 2009, 4(1), 26-29.

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