Week Five Questions, Coursework Example

Cost Allocation

It is the assigning of a common cost to numerous cost objects. For example, an organization might assign or allocate the cost of an expensive central processing unit system to the three main areas of the organization that uses the system. In addition, an organization with only one electric meter might allocate the cost of electricity to a number of departments in the organization. Cost allocation is the heart of most organizations cost accounting systems.

Cost allocation tries to link some costs or collection of costs with one or more cost purpose, such as departments, products, and divisions. This is accomplished by selection of cost drivers referred to as a cost-allocation base. For instance, newsprint for a printing company and direct professional labor for an organization may be allocated to jobs, departments, and projects, using the costs drivers as tones of newsprint consumed or direct-labor-hours used.

Objectives of Cost Allocation to an Organization:

1. To obtain desired motivation.

Cost allocations are made to influence management behavior and thus it promotes managerial effort and goal congruence. Some organization might opt not to allocate costs to services like internal management consulting services or internal services so as to encourage their use, but other opt to allocate cost to such services to make sure the benefits from the particular services exceed the costs.

2. To compute asset variations and income

Costs are allocated to projects and products to measure cost of goods sold and inventory cost. These allocations are used by the organizations to service financial accounting purposes. The resulting costs are often used by managers in performance evaluation, planning, and are a motivation to managers.

3. To obtain reimbursement and to justify costs.

 At some time, prices are based directly on costs, or it may be essential to validate an accepted bid. For instance, government agreements often stipulate a price that includes reimbursement for costs in addition to some profit margin. Cost allocation becomes an alternative for the common working of the marketplace in setting prices.

Cost Assignment/Cost Attribution

It is the process by which direct or indirect costs are made the responsibility of a particular cost centers, and eventually charged to the services provided or manufactured by the organization. Procedures used to achieve cost assignment include activity-based costing, absorption costing, and marginal costing.

Types of Cost Assignment

• Fixed/Direct Costs: They involve all the expenditure done on fixed factors of production process. Fixed costs always remain constant i.e. they will never differ with the level of output. For instance, Insurance premium, interest, wages, and rent of permanent employees.
• Variable/Indirect Costs: these are costs that do not remain constant; in essence, it varies with the level of output. E.g. expenditure made on fuel, power of raw materials, and salaries of casual employees.
• Opportunity Costs: Since resources are limited, the production of one product/commodity can be made possible at the cost of the other. The good that is given up is the opportunity cost of the product manufactured.
• Accounting Costs: They outline the exact expenditure incurred during the production.
• Economic Costs: these are the combination of normal profits, explicit cost, and implicit cost.
• Explicit Costs: these are the payments made to all the suppliers who provide the company equipments used in production and raw materials.
• Implicit Costs: it is the combined cost of self owned resources.
• Total Fixed Costs (TFC): it is a straight line curve that never changes with the level of output.
• Total Variable Costs (TVC): these are costs that are directly proportional to output, which implies TVC increases/decreases with input/output increase or decrease.
• Total Costs (TC): It is derived by adding (TFC) and the (TVC). All the changes in the Total Cost are due to the TVC due to the fact that TFC remain constant.

Costs that may be direct to a department could be fixed or variable. For instance, a manager in the printing section will be direct cost to the printing section. Since the manager’s salary is likely to be the same for every month regardless of the paper work printed, it becomes fixed cost or direct cost for the section. The supplies delivered to the printing section will be a direct cost to the section, but will be variable/indirect cost to the section if the whole amount of equipment used in the section increases as the activity in the section increases.

There can be a time when costs can be indirect cost in consideration to one cost object and direct cost in consideration to another object. For Example, salary engineer who supervises several plants would be taken as the indirect cost for any one of those plants. However, the engineer earnings would be a direct cost for the division encircling all of those plants.

By-products are products of relatively small value total value produced concurrently with the product of greater total value. The products of greater values are commonly referred to as the main product. The producer has limited control over the quantity of by-products that are produced. The accounting treatment of by-products requires a greater knowledge of the technological factors behind the manufacture, since the origin of the by-products may vary.

Methods of Costing of by-Products

• Recognition of gross revenue

This is when you overstate the cost of inventory of the main product to accommodate the costs of the by-products.

• Recognition of net revenue

This method assigns some costs for the by-product. Any marketing and processing of the by-product is recorded in a separate account.

• Replacement cost method

This is applied by firms whose by-products are used within the plant. It is not necessary to buy supplies and materials from outside.

• Market reversal cost method or value method.

The estimate must be made before the split-off from the main product. Control of the quantity is very important for this method.