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Cost Allocation: Support Costs And Joint Costs
I. Overview
Costs that cannot feasibly be directly associated with particular cost objects.
Support department costs and joint costs.
The direct method.
- The allocation may begin with the support department costs that (1) provide the highest percentage of its total support to other support departments, (2) provide support to the greatest number of other support departments, or (3) incur the greatest costs of support provided to other departments.
- The costs of the other department are then allocated, but no cost is assigned to departments whose costs have already been allocated.
- The process continues until all support costs are allocated.
Joint products.
The joint costs (common costs).
Separable costs.
- Physical unit method.
- Relative sale-value method.
- Estimated net-realized value (NRV) method.
- Constant gross-margin percentage NRV method.
Physical-unit method.
The relative sales-value method.
The estimated net-realizable-value (NRV) method.
- The percentage is the same for every product.
- The relative value is estimated if further processing is needed by subtracting the additional costs from the value of the final sale to determine the net realizable value.
To account for their value at the time of sale as a reduction in the cost of goods sold or as revenue.
II. Cost Allocation
Cost allocation.
- Choosing a cost object.
- Determining the indirect (nontraceable) costs that should be assigned to the cost object.
- Deciding how costs are to be accumulated in cost pools prior to allocation.
- Selecting the allocation base (not a driver).
Notes: It is not feasible to associate indirect costs directly with a given cost object; therefore, these costs must be allocated. Additionally, the method of allocation of indirect costs has no effect on the net income of the overall entity.
- Product costing (including determination of overhead rates).
- Pricing.
- Investment and disinvestment decisions.
- Managerial performance measurement.
- Make-or-buy decisions.
- Determination of profitability.
- Employee motivation.
Measuring income and assets for external reporting.
In the short term, management decisions are based on incremental costs without regard to fixed overhead because they cannot change in the short term.
Note: Thus, the emphasis in the short term should be on controllable costs.
Cause-and-effect criterion.
Cost pools are accounts in which similar costs are accumulated prior to allocation to cost objects.
Cost objects are the intermediate and final dispositions of cost pools.
If the costs charged are later reallocated to another cost object.
Note: Cost objects should be logically linked with cost pools, preferably on a cause-and-effect basis.
If the cost object is the job, product, or process itself.
Note: Cost objects should be logically linked with cost pools, preferably on a cause-and-effect basis.
III. Support Department Costs
Simultaneous-equations method.
Step-down method.
Actual short-run output based on predetermined rates.
The support department’s expected costs of long-run capacity.
1). The step-down method may start with the department that renders the highest percentage of its support to other support departments.
It then progresses in descending order to the support department rendering the least percentage of its support to the other support departments.
or
2). The step-down method may start with the department that renders the highest dollar value of support to other support departments.
or
3). The third alternative is, to begin with, the department that provides support to the greatest number of other support departments.
Direct method and step-down method.
- Under the direct method, support department costs are not allocated to other support departments.
- Under the step-down method, support department costs are acknowledged and allocated to other support departments, but no reallocation occurs.
IV. Introduction To Joint Costs
Joint process.
Determining inventory cost for accounting purposes.
- Additional process costs.
- Competitive conditions in sales markets.
- The relative contribution margins of all products are derived from the common process.
- It is identifiable as an individual product only upon reaching the split-off point.
- It has relatively significant sales value when compared with the other products.
A joint product has a relatively significant sales value compared with the other products, whereas a by-product has relatively minor sales values compared with the other products.
The costs assigned to inventories may have no relationship to value.
Similarities
- Similar physically.
- Account for in the same way.
- Scrap might even be considered a by-product of a manufacturing process.
Differences
- By-products usually have a greater sales value than Scrap.
- By-products are often subject to further processing in order to be saleable.
- Scrap rarely is processed further.
- Joint cost almost never is allocated to scrap, but the joint cost may be allocated to by-products.
V. Relative Sales Value
Net sales value at split-off.
Relative sales-value method.
VI. By-products
- Account for the by-products at the time of sale as a reduction in the joint costs or as revenue.
- Recognize the net realizable value at the time of production, a method that results in recording by-product inventory.
- By-products are joint products that have minor sales values compared with the sale values of the main products.
- To be salable, by-products may or may not require additional processing beyond the split-off point.
A portion of the joint production cost is allocated to the by-product plus any subsequent processing cost.
The by-products were treated as joint products even though they presumably met the definition of by-products because of their small relative sales values.
- To recognize scrap or by-products at the time of production or at the time of sale.
- Whether to treat the recognized amounts as contra costs or as revenues.
If the inventory is measured at NRV minus normal profit, recognition of normal profit is deferred until the sale of the product.
VII. Sell-or-Process-Further Decisions
Joint costs.
Incremental costs or differential costs.
To maximize profits, the company must determine whether the product’s incremental revenues exceed its incremental costs.
Profit maximization.
Profit maximization.
If the inventory is measured at NRV minus normal profit, recognition of normal profit is deferred until the sale of the product.