Going through this week’s resources, I found it difficult to pick just one resource. But alas, I choose the one listed above.
The three thing that I learned from reading this chapter are: Purpose of allocations, the three methods of allocating service department cost to producing department and three general methods of assigning cost to products.
Martin states that the purpose/need of cost allocations is to value inventory for external reporting purposes, for planning and monitoring the cost of activities and process and to make various short term and long-term decisions. Cost allocation is also needed to make decisions in government contracting. It is noted that cost allocation methods are components of overall performance evaluation systems and tends to influence the decisions and reaction of the participants within the system.
Second topic that I learned about are the three methods of allocating service department costs and overhead production cost. The first method discussed was using single plant wide overhead rate – considered the simplest approach to apply overhead to products. You do this by combining all overhead cost and calculating a single overhead rate. The next method, separate department overhead rate, referred to as the traditional two stage allocation approach. In this method, cost is divided between the producing department first and then applied to the products. The last method discussed is multiple activity based overhead rates for departments, or activity based product costing. This method also involves a two stage allocation process. The first stage is just like that of the second method discussed above. With the second stage, the overhead is separated into cost pools. This is done so that different types of cost can be traced to the products more accurately. (Martin, 2017)
Lastly, the three methods of assigning cost to product. The first is direct method – this simplifies the allocation process by ignoring self-services and reciprocal services between service department. Second is the step-down method – this method allows for partial recognition of reciprocal services while ignoring self-services. It differs from direct method because some service department costs are allocated to other service departments. The final method in this section is the reciprocal method – this method is said to be more accurate that the previous two but more involved. It includes three steps 1) develop equations for each department 2) solve the system for equations for the service department simultaneously and 3) solve the equations developed. for the methods mentioned above there are intricate equations used to calculate the cost to each department. (Martin, 2017)
This chapter had quite a lot of information to digest, but what I deducted from it all is that cost allocation is and can be very involved but essential to all businesses.