Cost Allocation Techniques Paper 5

Answer (A) is correct. If Xylo is processed further, the incremental sales revenue will be $6,000 [2,000 pounds × ($15 – $12)]. After subtracting the incremental costs, operating income will increase by $2,000 ($6,000 – $4,000).

Answer (C) is correct. The physical quantity (unit) method is the simplest; it allocates joint production costs to each product based on their relative proportions of the measure selected. Using this method results in a an identical unit cost for each separable product.

Answer (A) is correct. The total costs identified with products are unaffected by the treatment of indirect and common costs. The ability to identify a cost with a product is determined by traceability.

Answer (A) is correct. The sales value at split-off method is based on the relative sales values of the separate costs at split-off. Gross margin percentage is calculated as the difference between sales price and cost divided by sales price. Since each joint product receives the amount of separate cost proportional to its sales value, the gross margin percentage calculation will be the same. For instance, if there are two products whose sales prices are $40 and $60, respectively, the joint product costs allocated will also be in a 2:3 ratio, e.g., $10 and $15. 1. The first product will have a gross margin percentage of the following: 2. ($40 – $10) ÷ $40 = 75% 3. The second product will also have a gross margin percentage of the following: 4. ($60 – $15) ÷ $60 = 75%

Answer (C) is correct. Product 1 Product 2 Number of units 5,000 10,000 Price per unit × $8 × $10 Final sales price $40,000 $100,000 Separable costs (10,000) (30,000) Net realizable value $30,000 $ 70,000 This yields a total net realizable value (NRV) for the entire production run of $100,000 ($30,000 Product 1 + $70,000 Product 2). The next step is to allocate the total joint costs of $60,000 based on the proportion of the total NRV represented by each product: Product 1 = $60,000 × ($30,000 ÷ $100,000) = $18,000. Product 2 = $60,000 × ($70,000 ÷ $100,000) = $42,000. The cost per unit of Product 1 is therefore $2 ($10,000 ÷ 5,000 units) separable costs + $3.60 ($18,000 ÷ 5,000 units) joint cost = $5.60.

Answer (D) is correct. Allocating overhead on the basis of the number of units produced is usually not appropriate. Costs should be allocated on the basis of some plausible relationship between the cost object and the incurrence of the cost, preferably cause and effect. The fixed portion of overhead costs is incurred regardless of the level of production. When multiple products are involved, the number of units of production may bear no relationship to the incurrence of the allocated cost. If overhead is correlated with machine hours but different products require different quantities of that input, the result may be an illogical allocation. However, if a firm manufactures only one product, this allocation method may be acceptable because all costs are to be charged to the single product.

Answer (D) is correct. Under a normal costing system, overhead is applied to all jobs worked on during the period at a predetermined rate. Because cost of goods sold, finished goods inventory, and work-in-process inventory all relate to these jobs, each should be adjusted by its proportionate share of over- or underapplied overhead. This apportionment may be based on either the percentage of total overhead (theoretically preferable) or the percentage of total cost. The entry to close overapplied overhead requires credits to these three accounts.

Answer (D) is correct. Overapplied or underapplied overhead should be disposed of at the end of an accounting period by transferring the balance either to cost of goods sold (if the amount is not material) or to cost of goods sold, finished goods inventory, and work-in-process inventory. Theoretically, the allocation is preferred, but, because the amount is usually immaterial, the entire balance is often transferred directly to cost of goods sold. Thus, the entry depends upon the significance of the amount.

Answer (C) is correct. Extended normal costing assigns both direct costs (such as labor and materials) and overhead to cost objects by using budgeted rates. The direct cost assigned equals the budgeted rate times the actual amount of the direct-cost input. The overhead assigned equals the budgeted rate times the actual amount of whichever driver or other base is used for cost assignment purposes. The use of budgeted rates for overhead as well as direct costs may be helpful to avoid fluctuations during the year. It is also helpful when some direct costs, such as direct labor, may not be known until year end.

Answer (C) is correct. Theoretical (ideal) capacity is the maximum capacity given continuous operations with no holidays, downtime, etc. It assumes perfect efficiency at all times. Consequently, it can never be attained and is not a reasonable estimate of actual volume.