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Chapter

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

Learning Objectives
Identify the strategic role of cost allocation
Explain the ethical issues of cost allocation
Use three methods for allocating service
department costs to production departments
Explain problems in implementing each of the three
departmental cost allocation methods
Use the three methods for allocating joint product
costs
Understand alternative methods to account for byproducts 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 product
Motivate managers to exert a high level of effort
to achieve the goals of top management
Provide the right incentive for managers to make
decisions that are consistent with the goals
of top management
Fairly determine the rewards earned by managers
for their effort and skill and for the effectiveness of
their decision-making

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
An 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 exists
A 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
Approach
The Three Phases of Departmental Cost
Allocation

Departmental Approach:
Phase 2
Three methods are used to allocate service
department costs:

The direct method


The step method
The reciprocal method

Key Implementation
Issues
Choosing the most accurate method is key
Determining an appropriate
allocation
base and a percentage amount for service
provided by the service departments is
often difficult
Often firms have difficulty distinguishing
fixed and variable costs
Using budgeted vs. actual amounts?
Allocated costs can exceed external
purchase cost

Joint Product Costing

Three methods are commonly used to allocate joint product


costs
Advantages
Relative physical
units (measures) produced Disadvantages

Easy to use
The criterion for the
allocation of
the joint costs is objective

Ignores the revenue-producing


capability of individual products

Each product can have its own


unique physical measure

Relative sales values of the products


Advantages

Disadvantages

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

Advantages
Relative
net realizable values (NRV) of the products
Produces 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) Method


Other Income at Production Point Method

Revenue Methods:

Other Income at Selling Point Method


Manufacturing Cost Reduction at Selling
Point Method

The main difference between these


methods is the former grouping records byproduct produced as inventory at NRV, while

Asset Recognition
Methods

Revenue Methods