Cost Allocation

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Methods of Allocating Costs - Overview 1. Review the three Method of Allocating Costs. - Direct Method - Step Down Method - Reciprocal Method 2. Discuss the strengths and weaknesses of each method 3. Winery Problem – platform for discussing Joint Cost Allocations 4. Review remaining cost allocation problems. 5. Summarize and Review. State College Community Hospital State College Community Hospital has 2 Service Departments: 1. Maintenance 2. Food Services The Hospital also has three patient care units: 1. General Medicine 2. OB 3. Surgery Using the following information, we will allocate the costs of these 2 service departments to the 3 patient care units using the: 1. Direct Method 2. Stepdown Method – Maintenance First 3. Stepdown…show more content…
OB 30% ? General Medicine 30% ? Total ? 80% Food Service: Expected Use Allocated Cost Food + Maintenance Surgery 20% ? ? OB 15% ? ? General Medicine 45% ? ? Total 80% ? ? Direct Cost Allocation Strengths: 1. Easy to Calculate 2. Easy to Implement Weaknesses: 1. Misstates Opportunity Costs 2. Does not charge service departments for the use of other service departments Step-Down Allocation Strengths: 1. Reduces the subsidization of service department use of other service departments Weaknesses: 1. Misstates Opportunity Costs 2. Some service departments are not charged for the use of other service departments. 3. Selection of which department is allocated first results in different cost allocations. Reciprocal Method Strengths: 1. Theoretically correct method of allocating costs 2. Closest measurement of opportunity cost Weaknesses: 1. Seldom Used because math is misunderstood 2. Assumes all costs are variable, fixed costs should be allocated based on expected use, which introduce problems we have already discussed. Joint Costs 1. Joint costs are similar to common costs, but instead of an assembly process we are talking about a disassembly process. 2. Be very Careful in using Joint Cost allocations in : - Pricing Decisions. - Product Line profitability 3. Use Net Realizable Value (NRV) for

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