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Cost 1 Chapt-6

Cost allocation is the process of linking costs to cost objects like products, departments, or activities. There are two main types of departments: operating departments that add value and supporting departments that provide services. Costs can be allocated from supporting departments to operating departments using single rate or dual rate methods. The single rate method pools all costs and uses one allocation rate, while the dual rate method separates costs into fixed and variable pools with different rates. Cost allocation methods like direct method rank support departments based on the percentage or dollar amount of support provided to allocate costs.

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Tesfaye Megiso Begajo
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54 views8 pages

Cost 1 Chapt-6

Cost allocation is the process of linking costs to cost objects like products, departments, or activities. There are two main types of departments: operating departments that add value and supporting departments that provide services. Costs can be allocated from supporting departments to operating departments using single rate or dual rate methods. The single rate method pools all costs and uses one allocation rate, while the dual rate method separates costs into fixed and variable pools with different rates. Cost allocation methods like direct method rank support departments based on the percentage or dollar amount of support provided to allocate costs.

Uploaded by

Tesfaye Megiso Begajo
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We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter – 6 : Cost Allocation

Introduction
A cost accounting system collects and classifies costs and assigns them to cost objects
The goal of cost accounting is to measure the cost of designing, developing, producing
(purchasing), selling, distributing particular product/services.
Cost allocation is the heart of cost accounting system.
Cost allocation is fundamentally a problem of linking some costs or a group of costs
with one or more cost objectives such as:
products,
departments,
customer classes,
activities and
Divisions.
Operating Departments and Supporting Departments
Operating departments (also called a production department in manufacturing
companies) are departments which involved in changing the shape or size of an item
and add value.
Supporting departments (also called a service department) are departments that
provide services that maintain other internal departments.
• They are of three types:
1. Allocation of cost to the appropriate organizational unit:
• Direct costs are physically traced to the unit, but costs used jointly by more than one
unit are allocated based on cost driver activity in the unit.
• Eg. Allocating rent to departments based on floor space occupied,
• Allocating depreciation on jointly used machinery based on machine hour etc
2.   Reallocation of costs from one organization unit to another:
• When one unit provides products or services to another, the costs are transferred along
with the products or services. Some units exist only to support others, are called service
departments and their costs are totally reallocated.
Allocating of costs of a particular organizational unit or activity to products/service
• Allocating Costs from One Department to the Other (Supporting Department to
Operating Department or Division)
• Usually the cost of a department will include costs allocated from other departments.
• Three key issues that arise when allocating costs from one department to another are:
1.Whether to use a single rate method or a dual rate method
2.Whether to use budgeted rate or actual rate and
3.Whether to use budgeted quantities or actual quantities
•  Single rate and Dual rate method
• Single rate method:
• pools all costs in one cost pool and
• Allocates them to cost objects using the same rate per unit of the single allocation base.
• There is no distinction between costs in the pool in terms of cost variability (such as fixed or
variable cost).
• Dual rate method:
• Classifies costs in one cost pool into two sub pools (fixed cost sub pool and variable cost sub
pool).
• Each cost pool has a different allocation rate or a different allocation base.
• Illustration 1 : Assume that XYZ Company has a computer department which serves
Testing and Terminal departments only. The following data apply to the next budget year.
• Fixed cost of operating the facility ………………………………………..Birr 300,000 per year
• Total capacity available …………………………………………………. …1,500 hours
• Budgeted hours
• Testing department ……………………………………………………….. 800
• Terminal department …………………………………………...………… 400
• Total ………………..…………………………………… 1,200
• Budgeted variable cost per hour in the 1,000 – 1,500 hours relevant range..... $200/hour
used. Assume further that in the next year, Testing department actually uses 900 hours
and Terminal 300 only.
• Required: use the budgeted rate and budgeted usage as a base and allocate the XYZ
Company’s computer department cost under:
• Single rate method
• Dual rate method
Illustration 2 :Assume that the following data is given for BLK Company (with two support departments:
Maintenance and Information System; and two operating departments: Machining and Assembly) for
the year ended 2008 and it will be used to show how each support department cost allocation methods
are different to each other.
Support Departments Operating Departments
Maintenance Info system Machining Assembly
Budgeted FOH cost
Before allocation … $600,000 $116,000 $400,000 $200,000
Support work rendered:
By Maintenance
Budgeted labor hour ……… - 1,600 2,400 4,000
Percentage …………………. - 20% 30% 50%
By Information System
Budgeted service hour 200 - 1,600 200
Percentage 10% - 80% 10%
Direct method
Is most widely used
Allocates each support department costs directly to the operating departments
There are two approaches
Approach A: rank support departments based on the percentage of the support
department’s total support provided to other support departments. The support department
with the highest percentage is allocated first.
For our Example 3: percentage of total service provided to other support departments
Maintenance …………………………………………………….……… 20%
Inf. System ……………………………………………………….…….. 10%
Approach B: rank support departments on the total birr of service provided to the other
support departments.
For our Example
Birr amount of total service provided to other support departments
Maintenance …………………………………………….……… $120,000
Inf. System ……………………..………………………….……..$116,000
THANK YOU

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