Chapter 35
Managerial Accounting
Cost Allocation
Concepts
Prepared by Diane Tanner
University of North Florida
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Trend Towards Indirect Costs
 Automated manufacturing
environments experience
overhead costs that exceed 60%
of total product costs
 Recent trends
 Reduction of direct costs
 Creates greater indirect
costs
 More services provided
 Very little direct costs
 High levels of indirect costs
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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Criteria Used When Selecting
Allocation Bases
Problem: Identifying a relationship with indirect
fixed costs is not feasible
Relative
Benefits
 To allocate more costs to the cost
objectives that benefit most from
incurring the cost
Ability to  To allocate more costs to most
profitable products
Bear Costs
Equity
 To allocate fairly and equitably
http://news.bbc.co.uk/2/hi/europe/1759791.stm
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Approaches to Assigning Overhead Costs
 Traditional allocation
 A single “plant-wide” overhead rate used for entire
factory
 Normal costing
 Simple to use
 Traditional allocation bases




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
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Concerns of Using One Overhead Rate
 Can distort unit product costs
 Direct labor and other volume-based rates are
not highly correlated with overhead costs
 I.e., not all overhead costs increase for the
same reason
 Single allocation basis does not reflect the
activity for all overhead 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
Cost Hierarchies
• Cost hierarchies are levels in which costs occur.
Facility-level
activities
• Factory costs that impact all the products produced in
a factory, such as depreciation on the factory building,
factory insurance, factory janitors, factory supplies
Product-level
activities
• Costs specific to particular products such as training
employees how to produce it, quality control on a
product, etc.
Batch-level
activities
• Costs specific to particular batches of products such
as machine setup for a particular product, machine
maintenance between each batch, etc.
Unit-level
activities
• Costs performed every time a product is produced.
They are usually variable and correlate to the number
of products produced, such as packaging, sanding a
product edge, printing labels, etc.
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The End
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