Question

1. Give an example of why the statement, “all direct cost are avoidable,” is incorrect.

2. What are the important factors in determining the appropriate cost driver to use in allocating a cost? What type of cost drivers does the company for which you work use ( convenience store clerk)?

3. On January 31, the managers of Integra, Inc., seek to determine the cost of producing their product during January for product pricing and control purposes. The company can easily determine the cost of direct materials and direct labor used in January production, but many fixed indirect costs are not affected by the level of production activity have not yet been incurred. The managers can reasonably estimate the overhead cost for the year based on the fixed indirect costs incurred in past periods. Assume the managers decide to allocate an equal amount of these estimated cost to the products produced each month. explain why this practice might not provide a reasonable estimate of product cost in January

Answer 1

1. The statement "all direct cost are avoidable" states that the costs which are directly relatable to a product can be avoided that means the situtations under which these costs are required to be incurred can be controlled and avoided if required. For example direct material is a type of direct cost. The material will be required only when there is production in the house. If the company shuts its production the requirement of the direct material becomes nil and the cost of direct material is zero. Hence, the direct cost is avoided and it proves the statement.

2. The cost drivers are used by a company to allocate various factory overheads in an appropriate manner. The cost drivers are mainly ascertained on the basis of cost object. The cost object defines the purpose and categorization of the overhead. The convenience store may use the following as cost drivers -

No. of hours worked by Employee

Space occupied by different machines

No. of Routine Checks

No. of sales personnel

No. of departments

3. The decision of managers to allocate the indirect costs equally every month may not provide a reasonable estimate of product costs because the level of production every month may not be same and the level of activity may also differ every month. The equal distribution of the product cost every month will thus lead to low cost per unit in heavy production month and high product cost per unit in less production month.