Chapter 7: Joint Costing

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What are the 4 objectives of the Strategic Role of Cost Allocation?
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1. Determine ACCURATE DEPARTMENTAL AND PRODUCT COSTS as basis for the evaluation of the cost efficiency of departments and the profitability of different products for financial reporting and tax compliance 2. MOTIVATE managers to exert a high level of effort to achieve the goals of top management 3. Provide the right INCENTIVE for managers to make decisions that are consistent with the goals of top mgmt 4. FAIRLY determine the REWARDS
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What is the key motivation issue for the second objective of the Strategic Role of Cost Allocation?
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Whether manager can control the allocation cost. -If cost allocation for maintenance expense is the # of equipment breakdowns, the manager can control that. Can’t control square feet though so not good basis
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What is the major advantage of cost allocation for the 3rd objective of the Strategic Role of Cost Allocation?
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Draw manager’s attention to shared facilities are provide incentive for individual and joint efforts to manage those costs
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When is the most objective basis for cost allocation achieved for the 4th objective of the Strategic Role of Cost Allocation?
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When there is a cause and effect relationship
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What are some ethical issues involved in cost allocation?
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1. When costs are allocated to products that are produced for both a competitive market and a public agency the manufacturer may try to shift the costs to the cost-plus products so the competitive market products are less. 2. fair share issue that arises when government reimburses private institution or provides free service to public 3. Firms can reduce their worldwide tax liability by increasing costs of products purchased in high-tax countries
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3 Phases in Departmental Cost Allocation
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1. Trace direct costs and allocate indirect costs to all departments 2. Allocate service department costs to production department -reciprocal flows 3. Allocate production department costs to products
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Reciprocal Flows
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flow of services back and forth between service departments
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What are the 3 methods that accountants can choose from to allocate costs for the 2nd phase in Departmental Cost Allocation?
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1. Direct 2. Step 3. Reciprocal
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Direct method
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simplest of 3 methods b/c it ignores reciprocal flows. Accomplished by using the service flows only to production departments and determining each production department’s share of that service
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Step method
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uses sequence of steps in allocating service department costs to production departments -more accurate than direct b/c one of the reciprocal flows between the 2 service departments is considered in the allocation
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Reciprocal Method
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considers ALL reciprocal flows between service departments through simultaneous equations
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What are the 3 issues to consider when implementing the departmental allocation approach?
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Disincentive Effect when: 1. allocation base is unrelated to usage -if allocating maint. exp based on floor space, departments don’t have incentive to limit its use of maint. exp 2. allocation base is actual usage -problem b/c the usage of resources by one dept. will affect the cost allocation to other depts. -to solve this, use dual allocation 3. allocated costs exceed external purchase cost -can sometimes allocate a higher cost for the service than the dept. would pay if it were to purchase the service from an outside supplier
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Dual allocation
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separates fixed and variable costs and traces variable costs to the departments based on actual usage; fixed costs are allocated based on either equal share among departments or a predetermined budgeted portion
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Joint Products
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products from the same production process that have relatively substantial sales values
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By-products
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total sales values are minor in comparison to the sales value of the joint products
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Split-off point
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point in a joint production process at which individual products can be separately identified
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What do joint costs include?
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All manufacturing costs incurred prior to the split-off point
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Separable processing costs
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occur after the split-off point and can be identified directly with the individual products
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3 Methods for Allocating Joint Costs to Joint Products
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1. Physical Measure 2. Sales-value at split off 3. Net realizable value
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Physical Measure Method
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uses a physical measure such as pounds, gallons, yards, or unit of volume produced at the split-off point to allocate the joint costs to joint products. -can use units of input or units of output. If output, then thats called average cost method -easy to use -criterion for allocation is objective -BUT it ignores the revenue-producing capability of individual products that can vary widely among the joint products and have no relationship at all to any physical measure
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Sales Value at Split-off Method
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allocates joint costs to joint products on the basis of their relative sales values at the split-off point -can only be used when products can be sold at the split-off point -easy to calculate -allocated according to the individual product’s revenues -superior to physical measure b/c allocates joint costs in proportion to the product’s ability to absorb those costs -limitation: market prices for some industries change rapidly, and sales price at split-off may not be availbale b/c further processing is needed
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Net Realizable Value Method
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Estimated sales value of the product at the split-off point; determined by subtracting the separable processing and selling costs beyond the split off point from the ultimate sales value of the product -used when there is no market value attached to product at split-off point because further processing is needed before it’s sold NRV = Ultimate Sales Value – separable processing and selling cost
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2 Approaches of By-Product Costing
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1. Asset Recognition -records by-products as inventory at NRV -by-product is recognized as inventory when the by-product is produced 2. Revenue Approach -does not assign values to the by-products in the period of production but recognizes by-product revenue in the period sold
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2 Asset Recognition Methods
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1. NRV -shows NRV of by-products on the B/S as inventory, and as deduction from total manufacturing cost on I/S -done in period in which by-product is produced 2. Other Income at Production Point -shows NRV of by-products on the I/S as other income or other sales revenue -done in period in which by-product is produced
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2 Revenue Methods
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1. Other Income at Selling Point Method- shows NRV from a by-product sold at the time of sale on the I/S as other income or other sales rev 2. Manufacturing Cost Reduction at Selling Point Method-shows the net sales revenue from a by-product sold at the time of sale on the I/S as a reduction of total manufacturing cost

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