July 2002

Dual-Rate Cost Assignment to Evaluate Performance

By Paul Kimmel and Leslie Kren

Companies assign cost from one responsibility center (RC) to another to ensure that the final cost of a responsibility area includes the cost of support services along with the RC’s directly traced cost. A common approach is to assign service costs using a simple single-rate procedure. While easy to use, a single-rate procedure fails to distinguish between the cost of providing support services (variable cost) and the cost of being ready to serve (fixed cost). A dual-rate cost assignment procedure clarifies these distinctions and can improve performance evaluation and management behavior.

Single-Rate Approach

Service department cost is assigned to RCs using a cost driver that has a cause-and-effect relationship with the resource provided. Cost is assigned twice during a period: It is assigned at the beginning of the period as part of the budget process for strategic decision support, and it is assigned again at the end of the period, for performance evaluation (control).

To illustrate, consider Ace Manufacturing, which has two production departments, Fabricating and Assembly, and one service department, Maintenance. At the beginning of the period, the production departments budget their maintenance needs and the maintenance department budgets the associated service department cost (Exhibit 1).

At the beginning of the period, cost is assigned to Fabricating and Assembly from Maintenance as part of the budget process. This provides Ace with budget information for strategic and operational decision making. The budget performance report for Maintenance is shown in Exhibit 2.

At the end of the period, Ace makes another cost assignment to evaluate the performance of Fabricating, Assembly, and Maintenance. Two approaches are commonly employed: single-rate, budget-based and single-rate, actual-based.

Single-Rate, Budget-Based

In making the end-of-period cost assignment, some use the budgeted service department cost, thus assigning the same cost for evaluation purposes as was used for budget purposes. The end-of-period performance report for Maintenance in Exhibit 3 shows the results using this single-rate, budget-based approach.

The benefit to this approach is that user departments are shielded from the inefficiencies of service departments. Fabricating and Assembly are not assigned Maintenance cost in excess of its budget. That is, any cost overruns are not passed on to users. This improves the ability to evaluate the user departments.

There are problems, however, with the single-rate, budget-based approach:

Single-Rate, Actual-Based

A common alternative practice assigns service department cost at the end of the period based on the actual realization of service department cost and the cost driver. The calculations are shown in the Maintenance department performance report in Exhibit 4.

The benefit of this procedure is that all service cost is assigned to users so the “full” cost of the output of line departments (Fabricating and Assembly) can be easily calculated.

There are problems, however, with the single-rate, actual-based procedure:

Dual-Rate Procedures

The problems cited above occur because of the failure to recognize that two different types of cost are incurred by service departments: the cost of being ready to provide service, and the cost of providing service. Cost assignment procedures should treat these costs differently. Readiness to serve (fixed) costs should be assigned to users based on budgeted needs, because these budgets determine service capacity, and consequently determine the service department’s fixed costs. The costs (variable) of providing service should be assigned based on the actual quantity of the service used (see Exhibit 5).

To illustrate dual-rate cost assignment procedures, consider the cost and activity information in Exhibit 1 and beginning-of-period cost assignment for budget in Exhibit 6. Note that the variable cost rate is $12 per maintenance hour ($60,000/5,000 hours) and the fixed service cost is assigned based on the proportion of maintenance resource reserved for each department. [Although not illustrated here, if capacity information is available for the service department, then capacity management (for both service providers and users) can be facilitated if fixed costs are assigned based on the proportion of capacity available for each user department.]

The total cost assigned at the beginning of the period for the budget is the same as using single-rate procedures (Exhibit 2). The budget report in Exhibit 6, however, contains more information than the single-rate budget report in Exhibit 2 because the incremental cost of service and the cost of the resource that has been reserved for each user are separately reported and available for decision support.

At the end of the period, dual-rate procedures lead to significantly different results than either of the single-rate approaches, as shown in the Maintenance performance report (Exhibit 7).

The cost of providing service is assigned by multiplying the budgeted rate by the actual activity. Thus, users are charged at the budgeted rate for the level of service they actually use. If the service department is unable to provide service at the budgeted rate, as in this example, then the inefficiency remains the responsibility of the service department. For readiness-to-serve costs, the end-of-period cost assignment is the same as the beginning-of-period assignment, because it represents the cost of the service department capacity reserved for the user, and it should not change regardless of the service level provided or any service department inefficiencies.

Evaluating the performance of the Maintenance department is also facilitated with dual-rate procedures. Note that the difference between cost incurred and cost assigned to users is a meaningful spending variance since it is the difference between the flexible budget (the cost assigned to users) and actual costs incurred. This spending variance remains the responsibility of the service department and is not assigned to users.

Paul Kimmel, PhD, CPA, and Leslie Kren, PhD, CPA, are both professors at the University of Wisconsin–Milwaukee.

Robert H. Colson, PhD, CPA
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