Week 9 - Allocation of Support Department Costs

Question 1

What are the 4 objectives of cost allocation?

Answer 1

1. Make sound pricing decisions (price > true costs)
2. Compute profitability of each product or service line
3. Value inventory properly for external reporting
4. To motivate production managers & supporting employees

Question 2

What are the 4 different criteria that can be used for cost-allocation decisions?

Answer 2

1. Cause and Effect
2. Benefits Received
3. Fairness (Equity)
4. Ability to Bear

Question 3

What is an operating (production) department?

Answer 3

A user department that directly adds value to a product
or service with the support of the support department.

Question 4

What is a support (service) department?

Answer 4

Provides the services that assist other internal
departments in the company.

Question 5

What are the 2 advantages of using budgeted costs for allocation of costs?

Answer 5

1. It enables user departments to know allocation in advance
2. It provides incentives for the support department to
   control costs

Question 6

What are the 3 advantages of using budgeted usage?

Answer 6

1. Operating departments know their allocated costs in
   advance.
2. Budgeted usage measures long-term demand for support
   department services.
3. Prevents a user department’s charge from being affected by the short-run usage of other user departments.

Question 7

What is one disadvantage of using budgeted usage?

Answer 7

User departments could tend to understate their predictions of long-term usage to receive lower portion of fixed costs

Question 8

How do you address the disadvantage of user departments understating predicted usage when using budgeted usage for cost allocation?

Answer 8

Management can:
- Monitor and control the process (Use feedback to keep future predictions honest)
- Offer rewards
(E.g. bonuses for accurate predictions)
- Charge higher prices for inaccurate predictions (E.g. if usage exceeds budget, charge higher rate for excess usage)

Question 9

What is the single-rate method?

Answer 9

All costs grouped in the one cost pool and allocated using one cost allocation base

Question 10

What is the dual-rate method?

Answer 10

Differentiate between fixed and variable costs and allocate costs using different cost allocation bases

Question 11

What is the advantage and disadvantage of using the single-rate method?

Answer 11

• Advantage: simple to implement.
• Disadvantage: treats fixed costs in a manner similar to variable costs, which may not reflect the reality.

Question 12

What is the advantage and disadvantage of using the dual-rate method?

Answer 12

• Advantage: treats fixed and variable costs more realistically, E.g., Fixed costs relate to the decisions associated with capacity. Variable costs relate to the decisions associated with usage.
• Disadvantage: more complex to implement

Question 13

What are the 3 ways to deal with the interaction between support departments?

Answer 13

1. Direct
2. Step-down
3. Reciprocal

Question 14

What are the 4 features of the direct method?

Answer 14

• Ignores possibility of interaction among support departments
• Simplest to use
• Allocates each support department’s costs only to production departments
• Potentially the least accurate method (Especially when significant interactions occur among support departments)

Question 15

What are the 2 features of the step-down method?

Answer 15

• Acknowledges that interdepartmental relationships can occur (However, it is only a partial recognition.
• Costs are allocated in a sequential, step-down manner, using a specified ranking procedure, i.e., which one to be recognized.

Question 16

What are the features of the reciprocal method?

Answer 16

• Recognises the full effect of interactions between support departments
• Theoretically the most accurate method
• Makes use of simultaneous equations