Cost Allocation PDF

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Summary

Factory overhead allocation process and techniques....

Description

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COST ALLOCATION Factory Overhead Allocation • •

Cannot be uniquely or economically or conveniently traced to a product Assigned or shared among products that benefit from this costs

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The process of assigning and sharing manufacturing overhead is called allocation. Assigning indirect costs to cost objects These costs are not traced

Criteria for Cost-Allocation Decisions:  Cause and Effect relation – activities and drivers must be identified that cause resources to be consumed  Benefits Received – the beneficiaries of the outputs of the cost object are charged with costs in proportion to the benefits received.  Fairness (Equity) – the basis for establishing a price satisfactory to the government and its suppliers. ✓ Cost allocation here is viewed as a “reasonable” or “fair” means of establishing selling price  Ability to Bear – cost are allocated in proportion to the cost object’s ability to bear them ✓ Generally, larger or more profitable objects receive proportionally more of the allocated costs

Level of Cost: •

Out-put unit level costs: resources sacrificed on activities performed for each individual unit. Example- Manufacturing operation costs.

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Batch-level costs: resources sacrificed on activities performed for a group of units of product. Example- Machine set-up costs.

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Product sustaining costs: resources sacrificed on activities performed to support individual product or service. Example- product designing costs.

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Facility sustaining costs: resources sacrificed on activities performed that cannot be traced to individual product or service but to support the organization as a whole. Example- Advertising cost for promoting general image of the organization.

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Homogeneous Cost Pool: All costs have the same cause-and-effect or benefitreceived relationship with the cost allocation base that is the cost-driver.

COST ALLOCATION

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The Steps of Cost Allocation Determine the Cost Objective (Cost Object).

• Determine the product, service, department, etc., that is to receive the allocation.

• A cost pool is a grouping of individual costs, the sum of which is allocated using a single allocation base. • Cost pools include: Departments, Major Activities .

Form Cost Pools

Select an Allocation Base to Relate the Cost Pools to Cost Objects

• It is very important that the allocation base relates the cost pool to the cost object. • Allocation should be based on a cause and effect relationship between costs and cost objects.

Cost Allocation Methods

Traditional Cost Allocation ABC

Plant-wide overhead allocation

Simultaneous method

Department-based overhead allocation

Step down method

Traditional volumebased cost system

Direct method

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Plant wide Overhead Allocation •

Only one allocation base

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Mostly Direct Labor cost or Direct Labor hour is used.

Departmental Overhead Allocation

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Step – 1: Estimate manufacturing overhead costs for every department

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Step – 2: Choose an allocation base for each department

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Step – 3: Develop a departmental overhead rate for each production center;

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Step – 4: Assign overhead to products as they pass through the production center

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Step -5: Allocate all service department costs to production centers.

Allocating Costs of a Supporting Department to Production Departments

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Supporting (Service) Department – provides the services that assist other internal departments in the company

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Operating (Production) Department – directly adds value to a product or service

Methods to Allocate Support Department Costs

 Single-rate method – allocates costs in each cost pool (service department) to cost objects (production departments) using the same rate per unit of a single allocation base  No distinction is made between fixed and variable costs in this method  Dual-Rate method – segregates costs within each cost pool into two segments: a variable-cost pool and a fixed-cost pool.  Each pool uses a different cost-allocation base

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Allocation Method Tradeoffs

 Single-Rate method is simple to implement, but treats fixed costs in a manner similar to variable costs  Dual-Rate method treats fixed and variable costs more realistically, but is more complex to implement

Methods of Allocating Support Costs to Production Departments

Direct Step Down Reciprocal

Check Chapter 15 from Horngren’s Cost Accounting

COST ALLOCATION

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