Allocated cost

Allocated cost are being created by taking costs from one specific area and allocating them to another area . There are two types of cost allocation (S.A. Finkler, D. M. Ward, J.J. Baker 2007,p.51):

1. Allocation of indirect costs is an allocation that happens in the mids of the department, e.g. how much of the salary of the director ought to be assigned to each of the managers, that are working for him.
2. Allocation of costs from cost center or one particular department to another department, e.g. cleaning services in a company can allocate its cost to cost centers or many other departments. What is more, they might also be allocated to the particular employee.

Allocation of joint costs

Joint costs are causing a lot of problems for accountants. It is very easy to make a bad choice by taking into consideration the full information about costs. When the possibility of joint cost is confirmed, we have to decide whether or allocated it or not).There are four principal purposes that needs to be filled, so we could allocate these costs (S.A. Finkler, D. M. Ward, J.J. Baker 2007,p.63):

• giving the full disclosure of information, when making a decision
• very effective technique for motivating staff
• External and internal reporting chain
• costs computation, reimbursement.

Understanding Overhead

Some of the allocated costs are called overheads.This term addresses the ongoing business expenses, which are not applied to making a product or service. This means they are mainly indirect and are impossible to associate with any specific employee. They are also in the need of allocation to employees and some form of aggregation. It is as crucial for budgeting purposes as for estimating how much an enterprise ought to surcharge for service or product. There are events, when the overhead requires joint costs, e.g. the salary of the accountant because every employee is depending on his work. Although sometimes the costs might be assigned to one particular employee, the expenses of gathering the data on that topic are very high (S.A. Finkler, D. M. Ward, J.J. Baker 2007,p.51).

The Overhead Application Process

The Overhead Application Process consists of 6 operations (S.A. Finkler, D. M. Ward, J.J. Baker 2007,p.56):

1. choosing the base for allocating costs to employee or department
2. regulating budgeted cost and volume
3. figuring out the overhead rate
4. assessing the accurate base
5. administering the budget overhead application rate to the accurate number
6. clarifying year-end differences between certain total overhead and measure of the overhead applied during the year.

The reason for cost allocation

The main reason for allocating costs is to assign the costs as close to one specific employee as it is possible. There is a need for assigning a cost to another department and then to an employee. Sometimes, departments decide to change the order of operation and start with allocating cost to one employee (S.A. Finkler, D. M. Ward, J.J. Baker 2007,p.51).

Examples of Allocated cost

• Allocated cost is a cost that is shared between two or more departments or activities. An example of an allocated cost would be the cost of a piece of machinery that is used by two different departments. The cost of the machine would be allocated between the two departments based on how much each department uses it.
• Another example of allocated cost would be the cost of a building that is used by multiple departments. The cost of the building would be allocated between the departments based on the amount of space that each department occupies.
• A third example of allocated cost is the cost of a shared service, such as legal or accounting services. The cost of the services would be allocated between the departments that use the services based on the amount of time and resources used.

Advantages of Allocated cost

The following are the advantages of allocated cost:

• Allocated costs can give a more precise representation of how costs are allocated in an organization. Allocating costs to the different departments or projects, or to the resources or activities that consume them, allows for more accurate assessment of which departments or projects are the most profitable or cost-effective.
• Allocating costs allows organizations to more accurately measure the cost of a product or service, helping them to price their products or services competitively.
• Allocating costs also allows organizations to more accurately measure the cost of overhead items, such as utilities or rent, and apportion them fairly across the organization.
• Allocating costs helps organizations to better understand their cost structure, enabling them to more easily identify cost-saving opportunities and become more efficient.
• Allocating costs can help to ensure that resources are used efficiently and that departments or projects do not make decisions that are financially unsustainable.

Limitations of Allocated cost

The following are the limitations of allocated cost:

• Allocated costs can be misleading and can lead to inaccurate conclusions if they are not properly allocated. For example, when allocating costs to departments, it can be difficult to determine the correct amount of cost to allocate to each department.
• Allocated costs only take into account past costs and are not forward-looking, so they are not suitable for long-term planning.
• Allocated costs do not consider factors such as market conditions, consumer demand, or changes in technology, which can significantly affect future costs.
• Allocated costs cannot be used to compare performance between different departments or organizations, as differences in cost allocations can distort results.
• Allocated costs can be difficult to accurately track and monitor, as it is impossible to know exactly how costs will be allocated in advance.

Other approaches related to Allocated cost

One approach to allocating costs is to use various cost allocation methods. These methods include:

• Activity-based costing (ABC): This method of cost allocation assigns costs to activities based on the resources consumed by each activity. It is often used to identify the causes of costs and the cost drivers associated with them.
• Process costing: This method of cost allocation assigns costs to processes based on the materials, labor, and overhead associated with each process.
• Cost-plus pricing: This method of cost allocation assigns prices to products based on their costs and a predetermined markup.
• Transfer pricing: This method of cost allocation assigns costs to products or services exchanged between divisions within a company.

In summary, there are several methods used to allocate costs, including activity-based costing, process costing, cost-plus pricing, and transfer pricing. Each of these methods can be used to accurately assign costs to products and services.

Allocated cost — recommended articles

Differential costing — Costing system — Fixed budget — Cost behavior — Differential cost — Irrelevant cost — Normal cost — Cost model — Segment margin — Surplus lines

References

• Drury C., (2005), Management Accounting for Business, Cengage Learning EMEA, United Kingdom
• Finkler S.A., Ward D. M., Baker J.J., (2007), Essentials of Cost Accounting for Health Care Organizations, Jones & Bartlett Learning, USA
• Mowen M. M., Hansen D. R., Heitger D. L., (2011), Cornerstones of Managerial Accounting, Cengage Learning, USA
• McLean R., (2002), Financial Management in Health Care Organizations, Cengage Learning, USA
• Penner S.J., (2013), Economics and Financial Management for Nurses and Nurse Leaders, Springer Publishing Company, USA

Author: Witold Urjasz