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CH 3 Cost Assignment

The document discusses cost assignment in inventory valuation and profit measurement, focusing on the distinction between direct and indirect costs. It explains the use of cost allocations and allocation bases, emphasizing the importance of cause-and-effect allocations over arbitrary ones. Additionally, it outlines the two-stage allocation process for establishing departmental overhead rates and provides examples of overhead allocations for different products.

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12 views19 pages

CH 3 Cost Assignment

The document discusses cost assignment in inventory valuation and profit measurement, focusing on the distinction between direct and indirect costs. It explains the use of cost allocations and allocation bases, emphasizing the importance of cause-and-effect allocations over arbitrary ones. Additionally, it outlines the two-stage allocation process for establishing departmental overhead rates and provides examples of overhead allocations for different products.

Uploaded by

aina
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Part Two:

Cost accumulation for inventory valuation and profit


measurement

Chapter Three:
Cost assignment

Use with Management and Cost Accounting 9e


by Colin Drury ISBN 9781408093931
© 2015 Colin Drury
3.1a
Assignment of direct and indirect costs

• Direct costs can be specifically and exclusively identified with a given cost
object – hence they can be accurately traced to cost objects.

• Indirect costs cannot be directly traced to a cost object – therefore


assigned to cost objects using cost allocations.

• Cost allocations = process of assigning costs to cost objects that involve


the use of surrogate rather than direct measures.

• Surrogates known as allocation bases or cost drivers.

• For accurate cost assignment, allocation bases should be significant


determinants of the costs (i.e. cause-and-effect allocations).

• The additional costing systems use arbitrary allocations to a significant


extent whereas more recent (ABC) systems rely mainly on cause-and-
effect allocations.
3.2a
3.3a
3.4a

Assigning indirect costs using blanket overhead rates

• Some firms use a single overhead rate (i.e. blanket or plant-wide) for the
organization as a whole.

Example

Total overheads = £900 000

Direct labour / machine hours = 60 000

Overhead rate = £15 per hour


3.4b

• Assume that the company has 3 separate departments and costs and hours are
analysed as follows:

• Product Z requires 20 hours (all in department C)

Separate departmental rates should be used since product Z only consumes


overheads in department C.
3.4c

• A blanket overhead rate can only be justified if all products consume


departmental overheads in approximately the same proportions:

EXAMPLE
Product X spends 1 hour in each department and product Y spends 5 hours
in each department:
• Both blanket and departmental rates would allocate

 £45 (10 + 30 + 5) to X
 and £225 (45 * 5) to Y.

• If a diverse range of products are produced consuming departmental


resources in different proportions separate departmental (or cost
centre)rates should be established.
3.5

Cost centre overhead rates

• Where
 there are different centres (each with significant overhead costs)
 and products consume overhead costs for each centre in different
proportions,
 separate overhead rates should also be established for each
centre within a department.

• The terms cost centres or cost pools are used to describe allocation to
which overhead costs are initially assigned.

• Frequently cost centres / cost pools will consist of departments but they
can also consist of smaller segments within departments.
3.6a

The two-stage allocation process

• To establish departmental or cost centre overhead rates a two-stage


allocation procedure is required:

Stage 1 – Assign overheads initially to cost centres.

Stage 2 – Allocate cost centre overheads to cost objects (e.g. products)


using second stage allocation bases / cost drivers.
3.6b
3.8a

The annual overhead costs for a company which has three production
centres and two service centres (Materials procurement and General
factory support) are as follows:
3.8b
The following information is also available
3.9a
3.9b
Product A
Direct Cost
Batch (units) Unit cost
100 100 10,000

Overhead allocations
Batch (units) Unit cost Hours
Machine A 100 2.15 5 1,075
Machine B 100 3.80 10 3,800
Assembly 100 1.80 10 1,800

Total Cost 16,675


Unit Cost 166.75

Product B
Direct Cost
Batch (units) Unit cost
200 200 40,000

Overhead allocations
Batch (units) Unit cost Hours
Machine A 200 2.15 10 4,300
Machine B 200 3.80 20 15,200
Assembly 200 1.80 20 7,200

Total Cost 66,700


Unit Cost 333.50
3.10
3.11
3.12

(continued)
3.13

Traditional ABC
Product A 66.75 105.88
Product B 133.5 101.03

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