Cost Allocation Techniques Paper 8

Answer (C) is correct. The most important factor in budgeting manufacturing overhead is production volume. Many overhead items have variable costs, and those that are fixed with a relevant range of output may increase if production exceeds that range. The other essential consideration is management’s judgment with respect to the nature and amount of costs to be incurred and expectations for production volume. Because overhead is applied based on predetermined rates, accurate judgment is important.

Answer (D) is correct. The single-rate method combines fixed and variable costs. However, dual rates are preferable because they allow variable costs to be allocated on a different basis from fixed costs.

Answer (D) is correct. The three major methods of allocating service department costs, in order of increasing sophistication, are the direct method, the step-down method, and the reciprocal (or simultaneous-equations) method. The direct method is the simplest. It involves allocating all service department costs to production departments without recognizing any service provided by one service department to another. The step-down method is a sequential process that allocates service costs among service as well as production departments. However, once a department’s costs have been allocated, no additional allocations are made back to that department. The reciprocal method uses simultaneous equations to recognize mutual services. The latter method is the most complex.

Answer (D) is correct. The reciprocal method uses simultaneous equations to allocate each service department’s costs. It allocates costs by explicitly including the mutual services rendered among all departments. When service departments render services to each other, the use of the direct method or the step-down method would not be theoretically accurate. Accordingly, in such situations, the reciprocal method would result in the most accurate allocation.

Answer (C) is correct. Service department costs are indirect costs allocated to production departments to better determine overhead rates when the measurement of full (absorption) costs is desired. Overhead should be charged to production on some equitable basis to provide information useful for such purposes as allocation of resources, pricing, measurement of profits, and cost reimbursement.

Answer (D) is correct. Ability to bear, measured in terms of the cost object’s profitability, is not an acceptable method because it has a dysfunctional effect on management behavior. It penalizes high performance instead of rewarding profitability.

Answer (A) is correct. The cause-and-effect criterion seeks a relationship between cost and the cost objective (for example, an operating division) such that changes in total costs can be predicted based on activities of the cost objective. Thus, the number of employees in an operating division is likely to correlate with incurrence of costs by the personnel department.

Answer (D) is correct. The dual-rate method of allocating costs from one department to another involves classifying the costs to be allocated into two pools, one variable and one fixed.

Answer (D) is correct. The most effective way to encourage more use of a service is to keep the user from having to bear the cost of the service.

Answer (A) is correct. When a user is forced to bear a realistic cost for a service, the user is less likely to use an excessive amount of that service.