Chapter 4: Manufacturing Cost Allocation Answers to Review Questions

R4.1. Companies allocate costs to estimate or assess the costs of their cost objects (products, processes, divisions, etc.).

The main issue in cost allocation is that estimated costs are assigned to the cost objects, which are subject to inaccuracies due to the use of the allocation bases are arbitrarily chosen.

R4.2. There are three commonly used methods to allocate support costs:

1) the direct method;

2) the sequential (or step) method; and

3) the reciprocal method.

The direct method is the simplest method among all three, while the reciprocal method is the most complicated among all three.

R4.3.Cost allocation is the process of distributing an overhead cost across multiple products, business units, or cost objects/centers.

R4.4.Costs allocating serves three main purposes: 1) make decisions, 2) reduce non-value-added costs, and 3) determine pricing.

R4.5. 1) Add up total overhead in groups of costs pools;

2) Compute the overhead allocation rate by dividing total overhead by the total measure of cost allocation basis (e.g., number of direct labor hours);

3) Apply overhead by multiplying the overhead rate by the measure of allocation basis for each product.

R4.6. The three common methods used to allocate of costs support departments to operating/production departments are:

(1) direct method.

(2) sequential method, and.

(3) reciprocal method.

R4.7. A service department is a unit in a firm that is not involved directly in producing its goods or services. However, service departments provide services that enable the production departments to perform their functions.

Production departments, on the other hand, are the units that are directly involved in producing goods and services.

R4.8. The term reciprocal services refers to the situation in which two or more service departments provide services to each other.

R4.9. Under the direct method of service department cost allocation, all service department costs are allocated directly to the production departments, and none of these costs are allocated to other service departments.

Under the step-down method, a sequence is first established for allocation of service department costs. Then, the costs incurred in the first service department in the sequence are distributed among all other departments (production and other service departments) that use the services provided by that service department. The method proceeds in the same manner through the sequence of service departments.

Under the reciprocal-services method, a system of simultaneous equations is established to reflect the reciprocal provision of services among service departments. Then, the costs of all of the service departments are allocated among all of the departments that use services provided by the various service departments. The reciprocal-services method of service department cost allocation is the only method that fully accounts for the reciprocal services among service departments.

R4.10. Under the step-down method, the first department in the sequence is the service department that serves the largest number of other service departments. The second department in the sequence is the service department that serves the second-largest number of service departments, and so on. The sequence among tied service departments usually is an arbitrary choice.

R4.11.

- A single-stage cost allocation system uses a single, plantwide, rate to allocate costs.

- A two-stage system first allocates costs to departments or activities and then allocates costs from the departments or activities to the products or services.

R4.12. The plantwide allocation approach uses one cost pool to collect and apply overhead costs and, therefore, uses one predetermined overhead rate for the entire company. The department allocation approach uses several cost pools (one for each department) and therefore uses several predetermined overhead rates.

R4.13. The essential difference is the allocation of costs among service departments. The direct method makes no inter-service-department allocation, the step-down method makes a partial inter-service-department allocation, while the reciprocal method fully recognizes interservice-department activities. All three methods allocate costs to the production departments based on the production department’s relative use of the services provided by the service departments.

R4.14. Allocations usually begin from the service department that has provided the greatest proportion of its services to other service departments, or that services the largest number of other service departments. This criterion is used to minimize the unrecognized portion of reciprocal service department costs.

Another criterion used is the amount of cost incurred by the service department. That is, the reallocation begins with the service department that has the greatest amount of cost.