Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 3

What criterion should be used to determine the order of allocation from service departments when the step method is used? Explain why.

Step 1 of 2

Cost accounting system

This is a system designed for inhouse or internal managers and their decision making. Cost accounting information is not needed for comparison with other companies. This information is commonly used in financial accounting also, but it is primarily used by company managers for their decision making. It is important that cost accounting information is relevant for the decision making of the manager.

Cost allocation

It is easy to calculate the cost of product if components of the products are directly used and not shared like direct labor is not shared resource. It becomes difficult to allocated the cost of common resources like depreciation on machine or rent of warehouse building which is used for two products manufacturing.

Role of cost allocation comes into play when common cost needs to allocated to two or more products or departments. There different basis used for cost allocation like number units used, labors hours, area used by departments or products etc. Cost allocation base must be the one that best establishes the connection between the overhead incurred and the activity. Cause and effect basis can be effective way to identify cost allocation base.