Cost: Chapter 7

The Strategic Role of Cost Allocation

1.Determine accurate departmental and product costs as a basis for the evaluation of the cost efficiency of departments and the profitability of different products, financial reporting, and tax compliance 2. Motivate managers to exert a high level of effort to achieve the goals of the company 3. Provide the right incentive for managers to make decisions that are consistent with the goals of the company 4. Fairly determine the rewards earned by the managers •The most clear and unbiased basis for cost allocation exists when a cause-and-effect relationship can be determined

The departmental approach classifies manufacturing departments into production and service departments 3 phases:

1.Trace all direct costs and allocate indirect costs to the production and service departments 2.Allocate the service department costs to the production departments 3.Allocate production department costs to products

Phase 2, allocation of service department costs: whether, and to what extent, reciprocal cost flows are recognized?

3 methods can be used to allocate service department costs: 1.The direct method 1.Simplest. Ignores reciprocal flows. 2.The step method The reciprocal method

A concept which is commonly employed with allocation bases related to size is: Multiple Choice Cost shifting. Benefit received. Equity share. Cause-and-effect relationship. Ability-to-bear.

Ability-to-bear.

Which one of the following methods of cost allocation is completed by taking the service flows to production departments only and determining each production department's share of that service? Multiple Choice Direct method. Indirect method. Step method. Reciprocal method. Cross-functional method.

Direct method.

An overhead cost that can be traced directly to either a service or production department: Multiple Choice Is called a "flow through" cost. Requires less allocation effort. Is charged directly to that department. Must be variable. Must be fixed.

Is charged directly to that department.

Which of the following is an advantage of the net realizable value method? Multiple Choice It produces an allocation that yields a predictable, comparable level of profitability among the products. Market prices for some industries change constantly. The sales price might not be available. Conceptually superior to the revenue recognition method. It is easy to calculate.

It produces an allocation that yields a predictable, comparable level of profitability among the products.

Which one of the following methods of allocating joint costs uses a measure of weight, size or number of units to allocate joint costs to joint products? Multiple Choice Net realizable value method. Physical measure method. Product measure method. Cost measure method. Sales value at split-off method.

Physical measure method.

Separable processing costs

costs incurred after the split-off point 4 methods used to allocate joint product costs: 1.Physical measures 2.Sales values of the products at split-off 3.Net realizable values (NRV) of the products Constant Gross Margin Percentage Method

Production department

•(aka an operating department) •a unit of the manufacturing company that is involved directly in producing the company's product

Two Types of Joint Costs

•Shared costs related to centralized services •Joint costs cannot be directly assigned to any one unit of output •Because they are indirect, need to be assigned using some type of allocation method •Joint manufacturing costs for products that are not separately identifiable until some later point in the manufacturing process •Called the split-off point

Which of the following about joint costs is not true? Multiple Choice Joint costs are the cost of resources employed jointly in the production of two or more outputs. Joint costs are incurred in a service department. The costs cannot be directly assigned to any one of the outputs involved. Allocation is not always needed when joint costs are involved. Assignment is made through one or more consistent allocation procedures.

Allocation is not always needed when joint costs are involved.

In making decisions about whether to sell or further process joint products or by-products, allocation of common or joint costs is: Multiple Choice Essential. Useful. Irrelevant and should be ignored. Useful depending on the method chosen. The only way to get the true total product cost.

Irrelevant and should be ignored.

Allocation of service department costs to producing departments is the most complex of the allocation phase of departmental cost allocation because of the likely presence of: Multiple Choice Manager bias. Formula distracters. Repetitive steps. Reciprocal flows. Non-value adding activities.

Reciprocal flows.

A key ethical issue in cost allocation involves costing in an international context, because the choice of a cost allocation method can affect: Multiple Choice Management reward systems. Management fraud. Taxes in domestic and foreign countries. The firm's financial statements. The fair share of cost by a governmental unit.

Taxes in domestic and foreign countries.

What is the key implementation issue for cost allocation? Multiple Choice The managers' bias. The complexity of the equations. The time-intensive calculations. The changes to reporting in the financial statements. The choice of the most accurate allocation method.

The choice of the most accurate allocation method.

Method 1: Physical Measures

The physical measure method uses a physical measure of output such as pounds, gallons, or units to allocate the joint cost to joint products.

What is the split-off point? Multiple Choice A process that yields multiple outputs from a common resource input. A method that uses a physical measure such as pounds, gallons, yards, or units of volume produced at the split-off point to allocate the joint costs to joint products. The point in a joint production process where products with individual identities emerge. A method that uses units of output to allocate costs to products. The point in cost allocation that managers decide to split costs.

The point in a joint production process where products with individual identities emerge.

The reciprocal method of departmental cost allocation is preferred over the step method because it takes into account all the reciprocal flows between: Multiple Choice The service departments. The producing departments. Multiple products. Competing departments. Similar, but separate products.

The service departments.

Ethical Issues in Cost Allocation

•An ethical issue arises when costs are allocated to products or services that are produced for both a competitive market and a public or governmental entity - there is the incentive to shift costs from competitive products to cost-plus-based products, since cost-plus pricing can increase revenue and profits •Shifting costs can have tax implications as well •By choosing an allocation method that has the effect of increasing the costs of products purchased in high-tax countries or in countries where the firm does not have favorable tax treatment, the firm can reduce its overall tax liability

Joint product costing

•Some manufacturing plants yield more than one product from a common resource input •Called a joint production process •Joint products - products from a joint production process that have relatively substantial sales values •By-products - products whose total sales values are minor in comparison to the sales value of the joint products

service department

•a unit of the organization that performs one or more support tasks for production departments

Split off point

•the point in a joint production process at which individual products can be identified for the first time •Joint costs include all manufacturing costs incurred prior to the split-off point