 Hello, and welcome to the session. This is Professor Farhad. In this session, we're going to look at an example that deals with cost allocation, and specifically, I'm going to work the direct method. In the next session, we look at the step method as well as the reciprocal method. These lectures can be found on farhatlectures.com, which is my website, as well as other lectures that are helpful. So in the prior session, I did discuss how cost allocation work in this example. We will actually work an example. So that's the best way to learn this is to actually look at some numbers and see how it works. So we have Home Life Insurance Company has two service departments. So we have S1 and S2, the actuarial and the premium rating. So S1 is the actuarial, S2 is the premium. So we have two service department and two production departments. So we have P1 and P2, advertising and sales. It's an insurance company, yes. The distribution of each service department effort and percentage to the other department shown in the following table. So they're showing us first before we look at the percentage. Let's look at the direct cost of the department, including both variable and fixed. So those are the costs that are allocated to the actuarial. We have, we allocated $80,000 to the premium. We allocated $15,000. Those are service departments going to draw a line here to differentiate them. The advertising, we have $60,000 of overhead allocated and the sales department $40,000. Let's go back to this table. What we are saying is this, the actuarial department, from the actuarial department, from the actuarial department, we allocate 80% to the premium department. See, it's from two. So from the actuarial department, we allocate 80% to the premium department, which is a service department, 10% to the advertising and the 10% to sales. From the premium department, we allocate 20% to advertising and 20% to sales. So we don't allocate anything to the other service department. Regardless, for this example, we're only going to be using, we're not going to be using the allocation between service to service. Why? Because we're going to be starting by determining the cost allocated to advertising and sales using the direct method. What does the direct method implies? The direct method implies there is no allocation between service department. So all the $80,000 and all the $50,000, they're going to flow to the production. They don't allocate money to each other. This is how the direct department work, the direct method. So how are we going to allocate the $80,000? Well, guess what? Again, we're going to ignore the 80% here. The way we allocate the actuarial $80,000 is 10% to the advertising and 10% to sales. Well, 10% plus 10% equal to 20%. So basically the advertising is 10 over 20 and the sales department gets 10 over 20, which is 50% and 50%. So we're going to allocate the $80,000, which is 50% of $80,000, $40,000. So $40,000 goes to department A at the production one, which is advertising and $40,000 is allocated to P2. So basically we allocated the $80,000. The $15,000, how are we going to be allocating the premium? It says of the $15,000, 20% of our effort goes into advertising and 60% goes to sales. So 20% plus 60% for finding the ratios equal to 80. So the advertising, the ratio of the 80 is 20 over 80, which is 25%, and obviously the remainder is 60 over 80. 75% goes to the sales department. So basically what we do is we'll take $15,000, multiply it by 25%, and that's what's going to go to the advertising department. That's going to give us 3,750. So of this amount, 3,750 goes here and the remainder, which is going to be 11,000 to 50, which is 15,000 times 75%, which is 11,250. Okay, at this point, we can add up the cost allocated, that's 100, 103,750. So 103,750 to production one, and that's 40 plus 40, 80 plus 11,250 is 91,250. Okay, so this is how we allocated the service department to the production department, using which method? This is the direct method. In the next session, so I'm done with the direct method, I would look at the step method explaining this problem. If you have any questions, any comments by all means, email me. If you happen to be taking my class, see me in class, obviously if you're studying for your CPA exam, study hard, it's worth it. Or the CMA, for that matter.