Advanced : Allocation of service department costs to profit cen tres pl us a di scussion of
Question:
Advanced : Allocation of service department costs to profit cen tres pl us a di scussion of the arguments for and against allocat ions for performance measurement Radartech Ltd has two profit centres, Air and Marine. The profit centres make equipment for use in aircraft and ships. The company also has a number of service departments, three of which are administration, maintenance, and transport services.
Selected data from the company's budget for January 1988 are shown below.
The management of Radartech Ltd is reviewing its procedures for allocating serv1ce department costs. At present these costs are allocated to the profit centres by the direct method of allocation on the bas1s of budgeted activity measures shown in the data above.
Radartech Ltd also has a research and development (R&D)
department which has budgeted costs of £900 000 for January 1988. R&D costs are allocated to profit centres on the basis of actual sales Requirements
(a) Allocate the costs of the service departments to Air and Manne:
(i) by the direct method of cost allocation. and (ii) by the step (also called step-down or sequential) method of cost allocation and state your criteria for the sequence of allocation steps adopted. (10 mar1
(b) Assuming that the management of Radartech Ltd will continue to allocate the service departments costs. discuss (i) the su~ability of the cost allocation methods in part (a).
and (ii) what other activity measures could be adopted by the company. (6 marks)
(c) Examine the arguments for and against the adoption of cost allocations in the measurement of the performance of profit centres and their managers, and consider the extent to which these arguments apply to the allocation of R&D expenditure by Radartech Ltd.
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