Ch.

14 - Cost Allocations:

Constantly Allocating Costs:

• As To Time (Months, Years, Etc.)

⇒ Eg. Amortization/Depreciation

• To Cost Objects:
⇒ To Departments, Product Lines, Sales Territories, Etc

Purposes Of Cost Allocations:

1. Inventory Valuation (Cogs, Net Income, Etc)

2. Planning & Control (Decision-Making)

⇒ Add/Drop Product Lines
⇒ Pricing Decisions

3. Cost Re-Reimbursement
⇒ “Cost-Plus Pricing”

4. Motivation And Evaluation

Process Of Cost Allocation:

Determine:

1) Cost Object(S)
⇒ What You Want To Allocate The Cost To!

2) Cost "Pools"
⇒ How Costs Are Accumulated By The Accounting System

3) Cost Allocation "Base(S)"

⇒ Means Of Linking The “Pools” With The “Cost Objects”

Ch. 14 OH #1 OF 7
 ⇒ Cost Drivers?
• Cause and Effect Relationship?
• Benefits Received
• Fairness/Equity
• “Ability to Bear”

⇒ Accuracy?

Problems In Cost Allocations:

Computer Department’s Budgeted Costs:

Fixed Costs = $ 75,000 Per Month

Variable Costs = $ 5 Per Hour

Month #1:

• Production Dept. "A" Uses 1,200 Hrs.

• Production Dept. "B" Uses 800 Hrs.

• Service Dept.'S Costs = $ 87,000

Allocations:

Month #2:

• Production Dept. "A" Uses 1,200 Hrs.

• Production Dept. "B" Uses 300 Hrs.

• Service Dept.'S Costs = $ 84,500

Allocation:

Ch. 14 OH #2 OF 7
Problems:

1)

2)

Preferable Methods:

1) Allocate "Expected" Or "Standard Costs":

2) "Dual" (Or Multiple) Cost Allocation:

⇒ Use More Than One “Cost Pool”
⇒ Use More Than One “Base To Allocate “Pools”

Variable Costs:

Fixed Costs:

Example: Assume The Service Dept. Was Established With The Intent That 60% Of
Its Capacity Would Be Used By Dept. "A" And 40% By Dept. "B":

Allocations:
Dept. "A" Dept. "B"
Month #1:

Fixed:

Variable:

Month #2:

Fixed

Variable:

Ch. 14 OH #3 OF 7
 “Support or Service” Departments

 Allocated To Production Dept’s:

(And Therefore Eventually To The Units Produced)
Reasons For Allocating:

1) Product Costing

2) Cross Department Monitoring

Methods of Allocating:

1) "Direct Method":
⇒ Service Dept’s Are Allocated To The Production Dept’s Only!

2) "Step Method" (Or “Step-Down”:

⇒ Recognizes That Service Dept’s Provide Services To Each Other As Well As
Production Dept’s

3) "Reciprocal Services" Method:

⇒ Recognizes That Service Dept’s Provide Services To Other Service Dept’s (&
Production Dept’s) And Receive Services From Them
⇒ Do Not Ignore A Department After It’s Allocated
Accuracy?

Best Method?

This Course: Required To Do Manually With A Maximum of Two Service Dept.’s

Only!

Example:
Overhead
Departments: Budget: “Base”

1) Building Maintenance.... $ 10,000

2) Personnel........................ $ 9,500
3) Administration................. $ 12,500
4) Material Stores............…. $ 8,000

5) Machining.....................… $ 20,000
6) Assembling...................... $ 17,000
Total Overhead......... $ 77,000

Ch. 14 OH #4 OF 7
Cost Objects = Individual Products
Departmental Data:
# Of Mach. Total Direct Lab Requi-
Dept. Sq.Ft. Employ Hours Lab.Hrs Hrs Sitions
1 0 5 0 1,000 0 15
2 1,000 7 0 1,400 0 2
3 1,000 10 0 2,000 0 16
4 2,000 10 0 2,000 0 0
5 10,000 15 7,000 3,000 2,000 6,000
6 6,000 15 3,000 5,000 4,000 4,000
Total 20,000 62 10,000 14,400 6,000 10,033

1) The Direct Method:

Machining: Assembly:
Dept. O.H. $ 20,000 $ 17,000

Bldg. Maint.:

Personnel:

Administration:

Mat. Stores:

Total Overhead

Departmental Overhead Rates:

2) "Step Method":

Ch. 14 OH #5 OF 7
 Order Of Allocation:
Bldg.
Maint. Person. Admin. Store %'S
1)

2)

3)

4)

Service Department Allocations:

Bldg. Mater.
Maint. Person. Admin. Stores Machin. Assemb.
O.H. 10,000 9,500 12,500 8,000 20,000 17,000

(2)

(3)

(1)

(4)

Total Overhead Costs

Ch. 14 OH #6 OF 7
3) "Reciprocal Services" Method:

(Ignore "Administration + Material Stores Departments!)

Machining Assembly

Dept.’S Overhead

Bldg. Maint.

Personnel

Allocating Common Costs:

“Common Costs”:

⇒ Cost that is shared by two or more users

E.G. Cost of Delivery is $20 per kilometer. A delivery is made to “Hope” (150
kilometers) and to “Surrey” (50 kilometers)

1) “Stand-Alone” Cost Allocation Method:

Ch. 14 OH #7 OF 7
2) “Incremental” Cost Allocation Method:

Ch. 14 OH #8 OF 7