Chapter 14 Cost Allocation

Copyright 2003 Pearson Education Canada Inc.

Slide 14-149

Cost Allocation
Cost allocation is the process of assigning indirect costs to cost objects Four Purposes of Cost Allocation 1. 2. To provide information for economic decisions To motivate managers and employees

3.
4.

To justify costs or compute reimbursement

To measure income and assets for reporting to external parties

Copyright 2003 Pearson Education Canada Inc.

Pages 529 - 530

Slide 14-150

Criteria for Guiding Cost Allocation Decisions

Cause and effect allocate based on the variable or variables that cause cost to be incurred Benefits received allocate costs among the beneficiaries in proportion to the benefits each receives Fairness or equity allocate costs in such a manner as to be fair or reasonable for both parties Ability to bear allocate costs based on who can best absorb them
Copyright 2003 Pearson Education Canada Inc. Pages 530 - 532 Slide 14-151

Methods of Cost Allocation

Single rate allocate costs to cost objects using a single rate rate = manufacturing overhead costs / labour hours Dual-rate separate costs into cost variable and fixed cost pools allocate fixed costs as lump sums based on long-term usage allocate variable costs based on a single variable cost rate

Budgeted versus actual allocations most firms allocate at budgeted rates based on actual usage
Copyright 2003 Pearson Education Canada Inc. Pages 536 - 539 Slide 14-152

Allocating Support Department Costs

Direct approach allocate support costs directly to operating departments Step-down approach recognize some of the work support departments do for each other allocate support costs to other support departments and operating departments in a pre-determined order Reciprocal approach recognize all of the work support departments do for each other allocate support costs among all departments using their services
Copyright 2003 Pearson Education Canada Inc. Pages 539 - 545 Slide 14-153

Direct Approach to Cost Allocation

Support Departments
Plant Maintenance
Direct costs $600,000

Production Departments
Machinery Department
$225,000
$375,000 Direct costs Allocated costs Total costs $400,000 328,111 $728,111

Information Systems
Direct costs $116,000
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$103,111 $12,889

Assembly Department
Direct costs Allocated costs Total costs $200,000 387,889 $587,889

Page 541

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Step-down Approach to Cost Allocation

Support Departments
Plant Maintenance
Direct costs $600,000

Production Departments
Machinery Department
$180,000
$300,000 Direct costs Allocated costs Total costs $400,000 389,778 $789,778

$120,000

Information Systems
Direct costs $116,000 + Allocated costs $120,000
Copyright 2003 Pearson Education Canada Inc.

$209,778 $26,222

Assembly Department
Direct costs Allocated costs Total costs $200,000 326,222 $526,222

Pages 541 - 543

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Reciprocal Approach to Cost Allocation

Support Departments
Plant Maintenance
Direct costs $600,000
Allocated costs $24,082

Production Departments
Machinery Department
$187,225
$312,041 Direct costs Allocated costs Total costs $400,000 379,877 $779,877

$24,082

$124,816

Information Systems
Direct costs $116,000
+ Allocated costs $124,816
Copyright 2003 Pearson Education Canada Inc.

$192,652 $24,082

Assembly Department
Direct costs Allocated costs Total costs $200,000 336,123 $536,123

Pages 542 - 544

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Allocation of Common Costs

Common costs are costs of operating a facility, operation, activity area, or like cost object that is shared by two or more users

Stand-Alone Cost Allocation Method Allocate common costs on the basis of each users percentage of the total of the individual stand-alone costs
Incremental Cost Allocation Method Allocate common costs in order beginning with the primary user and then proceeding to secondary (incremental) users
Copyright 2003 Pearson Education Canada Inc. Pages 545 - 547 Slide 14-157