Tiara Eka Putri Iskandar (1213003)Edward Tandi (1213019)Ho, Charlie Hosana (1213053)Chapter Seven

Learning ObjectivesIdentify the strategic role of cost allocationExplain the ethical issues of cost allocationUse three methods for allocating service department costs to production departmentsExplain problems in implementing each of the three departmental cost allocation methodsExplain the use of cost allocation in service firmsUse the three methods for allocating joint product costs

Understand alternative methods to account for by-products associated with a joint production process

The Strategic Role of Cost Allocation

Determine accurate departmental and product costs as a basis for evaluating the cost efficiency of departments and the profitability of different productMotivate managers to exert a high level of effort to achieve the goals of top managementProvide the right incentive for managers to make decisions that are consistent with the goals of top managementFairly determine the rewards earned by managers for their effort and skill and for the effectiveness of their decision-making

Ethical Issues in Cost AllocationAn ethical issue arises when costs are allocated to products or services that are produced for both a competitive market and a public or governmental entityAn equity or fair-share issue arises when a governmental unit reimburses the costs of a private institution or when it provides a service to the public for a feeno single measure of equity existsA third ethical issue is the effect of the chosen allocation method on the costs of the products sold to or from foreign subsidiaries

The Departmental ApproachThe Three Phases of Departmental Cost Allocation

Departmental Approach: Phase 2Three methods are used to allocate service department costs: The direct method The step method The reciprocal method

Key Implementation IssuesChoosing the most accurate method is keyDetermining an appropriate allocation base and a percentage amount for service provided by the service departments is often difficultOften firms have difficulty distinguishing fixed and variable costsUsing budgeted vs. actual amounts?Allocated costs can exceed external purchase cost

Joint Product Costing

Relative physical units (measures) produced

Relative sales values of the products

Relative net realizable values (NRV) of the products

AdvantagesDisadvantages Easy to useIgnores the revenue-producing capability of individual productsThe criterion for the allocation of the joint costs is objectiveEach product can have its own unique physical measure

AdvantagesDisadvantages Easy to calculate Market prices for some industries change constantly Costs are allocated according to the individual products revenue Sales price at split-off might not be available because additional processing is necessary for sale

AdvantagesProduces an allocation that yields a predictable and comparable level of profitability

By-Product Costing

Four Methods: Two based on assets, two based on revenues:Asset Recognition Methods:Net Realizable Value (NRV) MethodOther Income at Production Point Method

Revenue Methods:Other Income at Selling Point MethodManufacturing Cost Reduction at Selling Point Method

The main difference between these methods is the former grouping records by-product produced as inventory at NRV, while the latter grouping recognizes by-product revenue in the period sold

Asset Recognition Methods

Revenue Methods