Final answer:
The step-down method allocates service department costs to producing departments and does not directly contribute to profit. When facing economic losses, firms must decide whether to continue producing or to shut down and incur only fixed costs, which is a key consideration in this method.
Step-by-step explanation:
The step-down method of allocating service costs refers to allocating the costs of service departments to producing departments within a company. The correct answer to the student's question is option a) Provide services to the entire company but do not produce a profit on their own. Service departments provide necessary functions that support the production departments and the entire company, but they do not directly generate profit through sales of products or services. It is a key method used in managerial accounting to ensure that the full cost of production, including these supportive services, is reflected in product costs.
When a firm is making economic losses, it faces a critical decision: to continue production where price equals marginal revenue and marginal cost, or to shut down and incur only its fixed costs. This shutdown point is where a firm needs to assess whether it is better to produce at a loss or to stop production to minimize losses. Even if production is halted, fixed costs that have already been incurred cannot be recovered immediately, and thus a firm might choose to continue operating if it can cover its variable costs with the sales revenue.