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CHAPTER 14: COST ALLOCATION - SERVICE DEPARTMENTS AND JOINT PRODUCT COSTS QUESTIONS 14-1 The objectives of cost allocation are to achieve effective cost management through methods which: 1. Motivate managers to exert a high level of effort to achieve the goals of top management 2. Provide the right incentive for managers to make decisions that are consistent with the goals of top management 3. Fairly determine the rewards earned by the managers for their effort and skill, and for the effectiveness of their decision making. These objectives are important for manufacturing, retail and service firms. 14-2 Joint products and by-products are derived from processing a single input or a common set of inputs. Joint products are products from the same production process that have relatively substantial sales values. Products whose total sales values are minor in comparison to the sales value of the joint products are classified as by-products. 14-3 Spoilage is a defective unit that is not going to be reworked. Waste is the residual material that has no recovery value, and for certain wastes such as nuclear or chemical wastes, firms need to incur additional cost to properly dispose of them. Rework are product units that do not meet quality standards and need to be remanufactured. Scrap is the residue from a production process that has a relatively minor or no recovery value. 14-4 There are three methods for departmental cost allocation: the direct method, the step method, and the reciprocal method. The direct method of cost allocation is done by taking the service flows to production departments only and determining each production department’s share of that service. The step method uses a sequence of steps in allocating service department costs to other service departments and then to production departments. The reciprocal method takes into account all the reciprocal flows between service departments through simultaneous equations. The reciprocal method is most preferred because it simultaneously takes into account all the reciprocal flows among service departments.
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14-5 The three phases of departmental cost allocation, which apply for each of the three methods (Question 14-4) are: 1. The initial allocation of all production and service costs to departments
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This note was uploaded on 10/26/2010 for the course MBA FIN301 taught by Professor Park during the Spring '10 term at Liberty.

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