CH 4 Cost Allocation

Cost Objects:

• Cost objects refer to things for which costs are determined, such as:

  • Products

  • Processes

  • Departments

  • Services

  • Activities

Determining the Cost of Cost Objects:

• Accountants use cost accumulation to determine the cost of a particular object.

• Cost accumulation involves identifying:

  • Cost objects

  • Cost drivers

Cost Drivers and Cost Accumulation:

• Secondary cost objects require identifying cost drivers.

• Cost drivers have a cause-and-effect relationship with cost objects.

Estimated vs. Actual Costs:

• Estimated costs are used for decision-making.

• Actual costs may differ due to potential inaccuracies but provide relevance and timeliness.

Assigning Costs in a Retail Business (In Style, Inc.):

• Bonuses were initially based on sales revenue but later tied to profitability.

• Cost tracing and cost allocation are needed to determine departmental costs.

Direct and Indirect Costs:

• Direct costs can be traced to a specific cost object.

• Indirect costs (overhead) require allocation.

Cost Allocation:

• Common costs support multiple cost objects but cannot be traced directly.

• Controllable costs can be influenced by managerial decisions.

• Cost allocation involves dividing and assigning costs to objects.

Steps in Cost Allocation:

1. Compute the allocation rate.

2. Multiply the rate by the weight of the cost driver.

Allocating Different Costs:

• Rental & Utility Costs: Allocate based on usage.

• Supplies & Advertising Costs: Allocate using total sales as the cost driver.

• Store Manager’s Salary: Arbitrarily allocated as no strong cost-driver relationship exists.

Profit Analysis by Department:

• Helps identify cost drivers for variable overhead costs.

• Volume measures like units produced, labor hours, and direct materials serve as cost drivers.

Selecting Cost Drivers:

• The best cost driver has the strongest cause-and-effect relationship.

• Multiple cost drivers may be necessary for accuracy.

Fixed Overhead Cost Allocation:

• Fixed costs do not change with production volume.

• Allocating fixed costs ensures rational distribution across products.

Joint Costs:

• Common costs incurred in producing multiple joint products.

• The split-off point determines when products become separate.

• Joint costs can be allocated by volume or relative sales value.

Effects of Cost Allocation on Employee Motivation:

• Impacts manager evaluations and resource distribution.

• Requires technical and interpersonal skills to handle emotional impacts.

Flashcard Questions:

1. What are cost objects?

2. What are the two primary components of cost accumulation?

3. How does a cost driver relate to a cost object?

4. Why do managers use estimated costs?

5. What is the difference between direct and indirect costs?

6. What are common costs?

7. What are the two steps in cost allocation?

8. Why is the store manager’s salary arbitrarily allocated?

9. What volume measures serve as cost drivers for variable overhead?

10. How should companies select the best cost driver?

11. What is a joint cost, and how is it allocated?

12. What is the impact of cost allocation on employee motivation?

13. What are the main types of cost objects?

14. What is the purpose of cost accumulation?

15. Why is cost allocation necessary for indirect costs?

16. What are the characteristics of a strong cost driver?

17. What are the differences between estimated and actual costs?

18. Why might multiple cost drivers be used in allocation?

19. How does cost allocation affect managerial decision-making?

20. What is the split-off point in joint cost allocation?

21. How do controllable costs differ from non-controllable costs?

22. What is the impact of cost allocation on profitability analysis?

23. How are fixed overhead costs allocated?

24. What are examples of volume measures used in cost allocation?

Comprehensive Study Guide: Cost Allocation Presentation

Introduction to Cost Allocation

Cost allocation is the process of identifying, accumulating, and assigning costs to cost objects. Understanding cost allocation is crucial for accurate financial reporting and managerial decision-making.

Key Concepts

Cost Objects

Cost objects refer to entities for which costs are measured, including:

• Products

• Processes

• Departments

• Services

• Activities

Cost Accumulation and Cost Drivers

• Cost accumulation involves gathering costs related to a cost object.

• Cost drivers establish the relationship between incurred costs and the factors that cause them.

• A secondary cost object relies on identifying cost drivers.

• A strong cost driver has a clear cause-and-effect relationship with a cost object.

Types of Costs

Estimated vs. Actual Costs

• Estimated costs are used for budgeting and forecasting.

• Actual costs provide precise data but may differ from estimates due to variability.

Direct vs. Indirect Costs

• Direct costs can be traced directly to a cost object (e.g., raw materials for a product).

• Indirect costs (overhead) must be allocated using cost drivers (e.g., utilities, rent).

Common and Controllable Costs

• Common costs support multiple cost objects but cannot be directly traced.

• Controllable costs can be influenced by management decisions.

Cost Allocation Process

Steps in Cost Allocation

1. Compute the allocation rate:

   • Allocation Rate = Total Cost / Total Cost Driver Units

2. Multiply the rate by the weight of the cost driver:

   • Allocated Cost = Allocation Rate × Cost Driver Units Used

Methods for Allocating Costs

• Rental & Utility Costs: Allocated based on usage.

• Supplies & Advertising Costs: Allocated using sales revenue as the cost driver.

• Store Manager’s Salary: Arbitrarily allocated due to lack of a strong cost-driver relationship.

Analyzing Profitability by Department

• Identifies cost drivers for variable overhead costs.

• Common volume-based cost drivers include:

  • Units produced

  • Direct labor hours

  • Direct materials used

Fixed Overhead Cost Allocation

• Fixed costs remain unchanged regardless of production volume.

• Allocating fixed costs ensures a rational distribution across cost objects.

Joint Cost Allocation

• Joint costs are incurred in the production of multiple products before they become separate.

• The split-off point marks where products are distinguished.

• Allocation methods:

  • By volume (units produced)

  • By relative sales value (proportional revenue contributions)

Impact of Cost Allocation on Employee Motivation

• Affects performance evaluations and resource allocation.

• Managers may perceive allocations as fair or unfair, affecting morale.

• Requires technical understanding and interpersonal skills to navigate challenges.

Review Questions

1. What are cost objects? Provide examples.

2. How does cost accumulation help determine the cost of a cost object?

3. What is a cost driver, and why is it important?

4. Why are estimated costs used in decision-making?

5. What distinguishes direct costs from indirect costs?

6. What are common costs, and how do they differ from direct costs?

7. Outline the two steps in cost allocation.

8. Why is the store manager’s salary arbitrarily allocated?

9. How do businesses allocate rental and utility costs?

10. What volume measures serve as cost drivers for variable overhead?

11. How should companies select the best cost driver?

12. Define joint costs and explain how they are allocated.

13. How does cost allocation impact profitability analysis?

14. What is the purpose of allocating fixed overhead costs?

15. Explain the significance of the split-off point in joint cost allocation.

16. What challenges do managers face in cost allocation?

17. How does cost allocation influence employee motivation?