Chapter 11, Problem 58P

Cost Allocation: Step Method with Analysis and Decision Making

Steamco is reviewing its operations to see what additional energy-saving projects it might adopt. The company’s manufacturing plant generates its own electricity using a process capturing steam from its production processes. A summary of the use of service departments by other service departments as well as by the two producing departments at the plant follows:

Direct costs (in thousands) in the various departments follow:

Steamco currently allocates costs of service departments to production departments using the step method. The local power company indicates that it would charge $480,000 per year for the electricity that Steamco now generates internally. Management rejected switching to the power company on the grounds that its rates would cost more than the $330,000 ($90,000 + $240,000) cost of the present, company-owned, system.

Required

1. a.      What costs of electric service did management use to prepare the basis for its decision to continue generating power internally?
2. b.      Prepare for management an analysis of the costs of the company’s own electric generating operations. (Use the step method.) The rank order of allocation is (1) S1, (2) S4, (3) S2, and (4) S3.
3. c.       Add a section to your analysis to management that you prepared for requirement (b) to indicate whether your answer there would change if the company could realize $174,000 per year from the sale of the steam now used for electric generating. (Assume no selling costs.)