Cost Allocation Methods

Cost Allocation Methods

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What are Cost Allocation Methods?

The cost allocation method is a process that facilitates identification and assignment of costs to products, departments, branches or programs based on certain criteria. When the allocation of costs is performed correctly, the business is able to account for its costs as well as trace them back to determine how they are making profits and losses.

How does it work?

The cost allocation method starts with the identification of cost driversCost DriversA cost driver is a unit that derives the expenses and sets a basis on which a particular cost is to be allocated between the different departments and on the basis of that driver’s activity completed in that particular period the cost is allocated. These are the structural determinants of the activities on which cost is being incurred and determine the behavior of the costs on an activity.read more. The cost drivers tend to change the level of the cost incurred by the business for any aligned or identified activity. The cost drivers are generally composed of a number of machine-hours, the number of direct labour and the count of payment processed, the count of purchase orders, and the count of invoices that are dispatched to the customers. The establishment of comprehensive cost allocation methods helps in fast decision making for the management as they tend to get access to the important data of cost allocation and utilization on periodic fronts. It additionally keeps labour staff motivated as the business tends to recognize the department or product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more that is the most profitable department. Since the data on cost allocationCost AllocationCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more becomes accessible to the management, it helps the management evaluate the department and the associated staff.

Methods of Cost Allocation

#1 – Identification of Cost Object

This is the starting step in the identification of costs, wherein the business attempts to find and classify the cost objects. The cost objects are required as it helps the business to determine effective costs on segregated levels. Additionally, such identification is also regarded as critical as the business or organization cannot go ahead with the process of cost allocation if the cost objectsCost ObjectsA cost object is a method that measures product, segment, and customer cost separately to determine the exact cost and selling price. read more are not known and defined.

The cost objects could be a project in the pipeline, product line, department, division, or entirely a new segregated brand. In parallel to this activity of determining the cost objects, the business identifies and determines the basis of the costsBasis Of The CostsCost basis is the valuation of assets at their original or at-cost price inclusive of incidental expenses determined after making relevant adjustments for dividends, stock splits and distribution of return on capital. It facilitates the taxation of assets.read more. The cost basis is basically the fundamental aspect basis allocation of costs that are performed on the cost objects.

#2 – Accumulation of Costs into the Cost Pool

Conclusion

The cost allocation methods basically focus in terms of accumulation of costs followed by the establishment of cost drivers and cost pools to establish cost objects further and then aligned such costs to the cost objects. Cost allocationCost AllocationCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more is basically a critical task for the business as it helps the business in determining the effective profit and loss for themselves, and this attribute further helps the management to establish effective decision-making policy.

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