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Chapter 14
Cost Allocation
Decisions
Prepared by
Diane Tanner
University of North Florida
Why Do We Allocate Costs?
1. GAAP requires full cost
information
2. To make decisions of pricing,
expansion, product dropping,
cost-plus contracts, etc.
3. Make managers conserve
resources
4. Create incentives for evaluating
efficiency of ‘fee’ based company
services
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Approaches to Assigning Overhead Costs
 Traditional allocation
 A single “plant-wide” overhead rate used for entire
factory
 Simple to use
 Traditional allocation bases
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Direct labor cost
Direct labor hours
Machine hours
Units produced
 Activity-based costing
 Multiple overhead rates—one for each activity
 Expensive to implement
 More accurate product costing
Criteria That Guide
Allocation Decisions
 Cause-and-effect
 Links the cost incurred to the reason for the cost
 Most used of all criterion in activity-based costing
 Benefits received
 Allocates the cost to the cost object that received
the benefit of the cost
 Equitable/fairness
 Problematic – Try making everyone happy with the
allocation basis chosen.
 Ability to bear costs
 Cost objects that can afford costs are allocated costs
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What is a Cost Object?
 A product, job, service provided, batch, or
department that will receive a portion of a
cost allocation
 Something for which we want to know its
cost
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What is a Cost Pool?
 A grouping of individual costs whose total is
allocated using one allocation base
 Often based on departments or the output of a
particular process in a company
 Usually consists of both variable and fixed costs
 Sometimes called a cost bucket
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What is a Cost Driver?
 An activity that causes the cost pool to increase
 Often called an activity base because more of
the activity ‘drives’ a cost up
# of
Customers
Products
Cost Objects
Activity Bases
# of DL
Hours
# of
Employees
# Sq.
Feet
# of
Inspections
# of
packages
Amt. of
DL$
# of
Crates
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Two Stages of Cost Allocation
1. Allocate to
Cost Pools
2. Allocate to
Cost Objects
Support Costs
Cost Pool 1
Product 1
Cost Pool 2
Product 2
Product 3
The End
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