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Chapter 6

Cost Allocation and Activity-Based Costing

Learning Objectives

  1. Explain why indirect costs are allocated.
  2. Describe the cost allocation process.
  3. Discuss allocation of service department costs.
  4. Identify potential problems with cost allocation.
  5. Discuss activity-based costing (ABC) and cost drivers.
  6. Distinguish activity-based costing (ABC) from activity-based management (ABM).

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McMaster Screen Technologies produces a variety of touch-screen displays used in phones, kiosks, automobile navigation devices, and numerous other applications.

Approximately 80 percent of the company's revenue comes from producing screens in large numbers for touch-screen phones and automobile navigation devices. The other 20 percent is related to low-volume orders for kiosks, custom electronic equipment, and military applications.

In recent months, Michael Soma, the CFO at McMaster, has become concerned about the apparent profitability of several products. In particular, some high-volume products, such as the Model ND32 touch screen used in automobile navigation systems, are barely breaking even, while low-volume products, such as the Model MK420 touch screen used in a military targeting device, are selling for much more than the cost of production. This surprised Michael because the company ...

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