The step-down method is a cost allocation approach used to assign indirect costs to various segments or products within an organization. It involves a hierarchical allocation of overhead costs, where costs are first assigned to the primary cost pools and then systematically allocated to secondary cost pools in a step-by-step manner.
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The step-down method is particularly useful when there are multiple indirect cost pools with varying degrees of interdependence.
The method involves a sequential allocation of costs, where the costs of the primary cost pool are allocated to the secondary cost pools in a predetermined order.
The allocation of costs from one cost pool to another is based on the relative usage or benefit received by the secondary cost pools.
The step-down method can provide a more accurate representation of the true cost of each segment or product by considering the interdependencies between different overhead activities.
The order of the step-down allocation can have a significant impact on the final cost allocations, so it is important to carefully consider the hierarchy of the cost pools.
Review Questions
Explain the purpose of the step-down method in the context of evaluating and determining whether to keep or discontinue a segment or product.
The step-down method is used to accurately allocate indirect costs to various segments or products within an organization. This is crucial when evaluating and determining whether to keep or discontinue a segment or product, as the true cost of each segment or product must be understood. By sequentially allocating overhead costs from primary to secondary cost pools, the step-down method provides a more accurate representation of the costs associated with each segment or product, enabling informed decision-making about their viability and profitability.
Describe how the step-down method differs from other cost allocation approaches, and explain why the step-down method may be preferred in the context of segment or product evaluation.
Unlike other cost allocation methods, such as the single-step method or the reciprocal method, the step-down method recognizes the interdependencies between different overhead activities and allocates costs accordingly. This is particularly important when evaluating and determining whether to keep or discontinue a segment or product, as the step-down method can provide a more accurate assessment of the true costs associated with each segment or product. By considering the hierarchical relationships between cost pools, the step-down method can better capture the indirect costs that may be shared or influenced by multiple segments or products, leading to more informed decision-making about their viability.
Analyze how the order of the step-down allocation can impact the final cost allocations, and explain the importance of carefully considering the hierarchy of the cost pools when evaluating and determining whether to keep or discontinue a segment or product.
The order of the step-down allocation can have a significant impact on the final cost allocations, as the costs of the primary cost pool are allocated to the secondary cost pools in a predetermined order. This means that the hierarchy of the cost pools is crucial when evaluating and determining whether to keep or discontinue a segment or product. If the cost pool hierarchy is not carefully considered, the resulting cost allocations may not accurately reflect the true costs associated with each segment or product, leading to potentially flawed decision-making. By thoughtfully establishing the cost pool hierarchy and the order of the step-down allocation, organizations can ensure that the true costs of each segment or product are properly captured, enabling more informed and strategic decisions about their viability and profitability.
The process of assigning overhead costs to various cost objects, such as products, services, or departments, based on a predetermined allocation basis.