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Unformatted text preview: 507 CHAPTER 26 (FIN MAN); CHAPTER 11 (MAN) COST ALLOCATION AND ACTIVITY-BASED COSTING EYE OPENERS 1. Product costs are used to determine the profitability of individual products. This is useful information in setting prices, deter- mining promotional strategies, or in deciding whether to stop making the product. 2. A company building aircraft carriers builds them one at a time. There is no opportunity for product cost distortion by incorrectly allo- cating overhead across products by using a single overhead rate. Thus, a single over- head rate can be supported on the basis of its simplicity and lack of distortion. 3. Management desires accurate product costs so that its decisions regarding products are correct. For example, the wrong product cost could lead to incorrect pricing or promo- tional strategies. 4. The same total cost is allocated under the three different approaches. The different cost assignment methods do not change the total to be assigned. 5. A single plantwide overhead rate will provide accurate product costing if products use production department activity-base quanti- ties in nearly the same ratio across depart- ments. For example, if Product X used 2 hours of Department A and 4 hours of De- partment B activity-base quantities and Product Y used 1 hour of Department A and 2 hours of Department B activity-base quan- tities, then a single rate approach would not cause distortion. This is true because the ra- tio of activity-base usage quantity is 1:2 for both products across the two departments. Additionally, if the production departments have nearly the same factory overhead rate, then there would be no need to use the mul- tiple production department rate method. 6. Under the multiple production department rate method, factory overhead rates are de- termined for each production department. Factory overhead is allocated to products depending on the amount of allocation base used in each department. Under the single plantwide rate method, one factory over- head rate is determined for the whole fac- tory and is allocated to products depending on the amount of allocation base used in the factory. 7. The production department factory overhead rates are determined by dividing the bud- geted production department factory over- head by the budgeted allocation base for each department. 8. An allocation base should measure the con- sumption of production department factory overhead cost. For example, direct labor hours or machine hours would be a good al- location base for a Fabrication Department, because as products consume these hours, they are likely consuming a proportionate share of factory overhead from the depart- ment. 9. When there are significant differences in the factory overhead rates across different pro- duction departments, and when the products require different proportions of allocation- base usage in each production department 10. Under activity-based costing, factory over- head costs are assigned to activity cost pools rather than production departments. pools rather than production departments....
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- Summer '11