first assignment cost

Cost Allocation

The process of identifying, accumulating, and assigning costs to costs objects

What is Cost Allocation?

Cost allocation is the process of identifying, accumulating, and assigning costs to costs objects such as departments, products, programs, or a branch of a company. It involves identifying the cost objects in a company, identifying the costs incurred by the cost objects, and then assigning the costs to the cost objects based on specific criteria.

When costs are allocated in the right way, the business is able to trace the specific cost objects that are making profits or losses for the company. If costs are allocated to the wrong cost objects, the company may be assigning resources to cost objects that do not yield as much profits as expected.

Types of Costs

There are several types of costs that an organization must define before allocating costs to their specific cost objects. These costs include:

1. Direct costs

Direct costs are costs that can be attributed to a specific product or service, and they do not need to be allocated to the specific cost object. It is because the organization knows what expenses go to the specific departments that generate profits and the costs incurred in producing specific products or services . For example, the salaries paid to factory workers assigned to a specific division is known and does not need to be allocated again to that division.

2. Indirect costs

Indirect costs are costs that are not directly related to a specific cost object like a function, product, or department. They are costs that are needed for the sake of the company’s operations and health. Some common examples of indirect costs include security costs, administration costs, etc. The costs are first identified, pooled, and then allocated to specific cost objects within the organization.

Indirect costs can be divided into fixed and variable costs. Fixed costs are costs that are fixed for a specific product or department. An example of a fixed cost is the remuneration of a project supervisor assigned to a specific division. The other category of indirect cost is variable costs, which vary with the level of output. Indirect costs increase or decrease with changes in the level of output.

3. Overhead costs

Overhead costs are indirect costs that are not part of manufacturing costs. They are not related to the labor or material costs that are incurred in the production of goods or services. They support the production or selling processes of the goods or services. Overhead costs are charged to the expense account, and they must be continually paid regardless of whether the company is selling goods or not.

Some common examples of overhead costs are rental expenses, utilities, insurance, postage and printing, administrative and legal expenses , and research and development costs.

Cost Allocation Mechanism

The following are the main steps involved when allocating costs to cost objects:

1. Identify cost objects

The first step when allocating costs is to identify the cost objects for which the organization needs to separately estimate the associated cost. Identifying specific cost objects is important because they are the drivers of the business, and decisions are made with them in mind.

The cost object can be a brand , project, product line, division/department, or a branch of the company. The company should also determine the cost allocation base, which is the basis that it uses to allocate the costs to cost objects.

2. Accumulate costs into a cost pool

After identifying the cost objects, the next step is to accumulate the costs into a cost pool, pending allocation to the cost objects. When accumulating costs, you can create several categories where the costs will be pooled based on the cost allocation base used. Some examples of cost pools include electricity usage, water usage, square footage, insurance, rent expenses , fuel consumption, and motor vehicle maintenance.

What is a Cost Driver?

A cost driver causes a change in the cost associated with an activity. Some examples of cost drivers include the number of machine-hours, the number of direct labor hours worked, the number of payments processed, the number of purchase orders, and the number of invoices sent to customers.

Benefits of Cost Allocation

The following are some of the reasons why cost allocation is important to an organization:

1. Assists in the decision-making process

Cost allocation provides the management with important data about cost utilization that they can use in making decisions. It shows the cost objects that take up most of the costs and helps determine if the departments or products are profitable enough to justify the costs allocated. For unprofitable cost objects, the company’s management can cut the costs allocated and divert the money to other more profitable cost objects.

2. Helps evaluate and motivate staff

Cost allocation helps determine if specific departments are profitable or not. If the cost object is not profitable, the company can evaluate the performance of the staff members to determine if a decline in productivity is the cause of the non-profitability of the cost objects.

On the other hand, if the company recognizes and rewards a specific department for achieving the highest profitability in the company, the employees assigned to that department will be motivated to work hard and continue with their good performance.

Additional Resources

Thank you for reading CFI’s guide to Cost Allocation. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Break-Even Analysis
• Cost of Production
• Fixed and Variable Costs
• Projecting Income Statement Line Items
• See all accounting resources

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Why Allocating Costs Is Important for Your Small Business

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Business owners use cost allocation to assign costs to specific cost objects. Cost objects include products, departments, programs, and jobs. Cost allocation is necessary for any type of business, but it's more frequently used in manufacturing businesses that incur a wider variety of costs.

Overview: What is cost allocation?

Part of doing business is incurring costs. To ensure accurate financial reporting, it’s vital these costs are allocated to the appropriate cost object.

While bookkeepers and accounting clerks may need some guidance in properly allocating expenses, using accounting software can help to automate and simplify the entire process considerably.

To track and allocate costs, the cost needs to first be associated with a specific cost object. For example, your company pays $3500 property insurance annually for two buildings you currently own.

One building is 4,000 square feet, while the other building is 8,000 square feet. Your cost object is the square footage of each building, which will be used to allocate the cost to the correct building.

3 types of costs

Most businesses incur a variety of costs while doing business. These costs can range from the cost of materials needed to produce a finished product, to the direct labor wages paid to the employee running the machine used to assemble the product, to the overhead costs you incur every day simply by opening your doors.

Before you get started, familiarize yourself with the various types of costs your business is likely to incur.

1. Direct costs

A direct cost is anything that your business can directly connect to a cost object. Tied directly to production, direct costs are the only costs that need not be allocated, but instead are used when calculating cost of goods sold.

The most common direct costs that a business incurs include direct labor, direct materials, and manufacturing supplies. An employee working the assembly line is considered direct labor, a direct cost.

Same goes for the plastic needed to manufacture a toy, or the glue that holds pieces of the toy together. Direct costs are almost always variable because they vary based on production levels. However, if production remains constant, direct costs may remain constant as well.

2. Indirect costs

Indirect costs are costs incurred in the day to day operations of your business. Indirect costs cannot be tied back to one particular product, but are still considered necessary for production to occur or services to be delivered.

Indirect costs, such as utilities and line supervisor salaries are considered necessary for production, but are not tied to a specific product or service, so they’ll need to be allocated accordingly.

3. Overhead costs

Overhead costs, also known as operating costs are the everyday cost of doing business. Overhead costs are never tied to production, either directly or indirectly, but instead are the costs that your business incurs whether or not they’re producing goods or providing services.

For example, rent, insurance, and office supplies are considered overhead costs, which are costs incurred regardless of production levels.

Some overhead costs such as supplies and printing can be variable, while others, such as rent, insurance, and management salaries are all fixed costs, since the cost does not change from month to month. Like indirect costs, overhead costs will need to be allocated regularly in order to determine actual product cost.

Cost allocation examples

Cost allocation isn’t only necessary for manufacturing companies. There are plenty of reasons other companies may need to allocate costs.

Allocating an employee’s salary between two departments, allocating a utility bill between administrative and manufacturing facilities, or a nonprofit that needs to allocate costs between various programs are just a few reasons almost any business may need to regularly allocate costs.

When allocating costs, there are four allocation methods to choose from.

• Direct labor
• Machine time used
• Square footage
• Units produced

In the examples below, we used the square footage and the units produced methods to calculate the appropriate cost allocation.

Cost allocation example 1

Ken owns a small manufacturing plant, with administrative offices housed on the second floor. The square footage of the plant is 5,000 square feet, while the administrative offices are 2,500 square feet, with rent for the entire facility $15,000 per month. Rent must be allocated between the two departments.

The calculation would be:

$15,000 (rent) ÷ 7,500 (square feet) = $2 per square foot

Next, Ken, will calculate the rental cost for the plant:

$2 x 5,000 = $10,000

That means that Ken can allocate $10,000 to overhead expenses for the factory.

Next, Ken will calculate the rental cost for the administrative offices:

$2 x 2,500 = $5,000

The balance of the rent, $5,000, will be allocated to the administrative offices.

Cost allocation example 2

Carrie’s manufacturing company manufactures backpacks. In July, Carrie produced 2,000 backpacks with direct material costs of $5.50 per backpack, and $ 2.25 direct labor costs per backpack.

She also had $7,250 in overhead costs for the month of July. Using the number of units produced as the allocation method, we can calculate overhead costs using the following overhead cost formula:

$7,250 ÷ 2,000 = $3.63 per backpack

When added to Carrie’s direct costs, the cost to produce each backpack is $11.38, calculated as follows:

• Direct Materials: $ 5.50 per backpack
• Direct Labor: $ 2.25 per backpack
• Overhead: $ 3.63 per backpack
• Total Cost: $11.38 per backpack

If Carrie did not allocate the overhead costs, she probably would have underpriced the backpacks, resulting in a loss of income.

No, cost allocation is necessary for any business including service businesses and nonprofit organizations.

To track and allocate costs, the cost needs to be identified with a cost object, which costs are assigned to. Cost objects can include:

• Departments

Almost anything can be considered a cost object if you’re able to assign a cost to it.

Yes. While larger companies may have a greater need to allocate costs, smaller businesses can also benefit from allocating costs properly.

For example, even a small car repair shop will need to allocate parts and labor costs properly, while a small consulting business will need to allocate travel costs to the appropriate customer.

Why you should be allocating costs

Cost allocation is important for any business, large or small. How can you determine how much to charge for goods or services if you have no idea how much it costs to produce the goods or services you currently offer your customers?

Properly allocating costs is also essential for accurate financial reporting. Business owners rely on financial statements to make management decisions, and if the reports are inaccurate, it’s likely the decisions made will negatively affect the business.

Finally, allocating costs properly can help you identify profitable areas of your business and products or services that may be losing money, enabling you to make proactive decisions regarding both.

There’s no good reason not to allocate your business costs, so why not get started today?

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Cost Allocation – Meaning, Importance, Process and More

Cost Allocation or cost assignment is the process of identifying and assigning costs to the various cost objects. These cost objects could be those for which the company needs to find out the cost separately. A few examples of cost objects can be a product, customer, project, department, and so on.

The need for cost allocation arises because some costs are not directly attributable to the particular cost object. In other words, these costs are incurred for various objects, and then the sum is split and allocated to multiple cost objects. These costs are generally indirect. Since these costs are not directly traceable, an accountant uses their due diligence to allocate these costs in the best possible way. It results in an allocation that could be partially arbitrary, and thus, many refer cost allocation exercise as the spreading  of a cost.

Examples of Cost Allocation

• Cost Allocation – Importance

Cost Allocation Method

Define costs, identify cost objects, basis of allocation, accumulate costs into cost pool.

For example, a company’s CEO uses his car for personal and official purposes. So, if the CEO decides to allocate costs, then they will divide the cost (fuel, maintenance, etc.) for business and personal use based on usage.

The following examples will help us understand the cost allocation concept better:

• A company has a building in which there are various departments. One can allocate depreciation costs to the department on the basis square ft area of each department. This cost will then be further assigned to the products on which the department works.
• An accountant can attribute electricity that a production facility consumes to different departments. Then the accountant can assign the department’s electricity cost to the products that the department works on.
• An employee works on three products for a month. To attribute their salary to three products, an accountant can use the number of hours the employee gave to each product.

Cost Allocation – Importance

The following points reflect the importance of allocating costs:

• Allocating cost is essential for financial reporting, i.e., to correctly assign the cost among the cost objects.
• It allows the company to calculate the true profitability of the department or function. This profitability could serve as the basis for making further decisions for that department or service.
• If cost allocation is correct, it allows the business to identify and understand the costs at each stage and their impact on the profit or loss. On the other hand, if the allocation is incorrect, the company may end up making wrong or inconsistent decisions concerning the distribution of resources amongst various cost objects.
• The concept is also useful for finding the transfer prices when there is a transaction between subsidiaries.
• It helps a company make better economic decisions, such as whether or not to accept a new order.
• One can also use the concept to evaluate the performance of the staff.
• It helps in better explaining to the customers the costs that went into the pricing of a product or service.
• Allocation cost helps a company know where the money is going and how much. It will assist the company in using the resources effectively. Pool costs, if not allocated, may give an unbalanced view of the cost of various objects.

As such, there is no specific method to allocate costs. So, an accountant needs to use his or her due diligence to assign a cost to the cost object. Of course, they are considering the practice adopted in a similar industry. For instance, the accountant may decide to allocate expenses based on headcount, area, weightage, and so on.

Also Read: Cost Object – Meaning, Advantages, Types and More

Irrespective of the method an accountant uses, their objective should be to allocate the cost as fairly as possible. Or to allocate cost in a way that is in line with the nature of the cost object. Or to lower the arbitrariness in awarding costs.

Several efforts are underway to better cost allocation techniques. For instance, the overhead allocation for manufacturers, which was on plant-wide rates, is now based on departmental standards. Also, accountants use machine hours instead of direct labor hours for allocation.

Moreover, some accountants are also implementing activity-based costing to better the allocation. So, there can be several ways to allocate costs. But, whatever form the company selects, it is essential to document the reasons backing that method, and that need to be followed consistently for several periods.

A company can ensure documentation by developing allocation formulas or tables. Moreover, if a company wants, it can also pass supporting journal entries to transfer costs to the cost objects or do it via the chargeback module in the ERP system.

Also Read: Cost Hierarchy – Meaning, Levels and Example

Nowadays, cost allocation systems are available to assist in cost allocation. Such systems track the entity that produces the goods or services and the body that consumes those goods or services. The system also identifies the basis to distribute the cost.

The process to Allocate cost

As said above, there are no specific methods for allocating costs. Similarly, there is no particular process for it, as well. However, the process we are detailing is one of the most popular, and many companies use it for allocating costs. Following is the process:

Before allocating the cost, a company must define the various types of costs. Generally, there are three types of costs – direct, indirect, and overhead. Direct costs are those that one can easily attribute to a product or service, such as wages to factory workers or raw material for the specific product.

Indirect costs are ones that a company needs to incur for its operations, such as administration costs. Primarily, these are the costs that a company needs to allocate as it is difficult to attribute them directly to a product or service or any other cost object.

Another type of cost is an overhead cost , which is also an indirect cost. These costs are incurred for the production and selling of goods or services. Such costs do not vary based on production or sales. A company needs to pay them even if it is not producing or selling anything. Research and development costs, rent, etc., are good examples of such a cost.

The company or the accountant must know the cost objects for which they need to allocate the cost. It is crucial as we can’t assign costs to something on which we have no information. A cost object could be the product, customer, region, department, etc.

Along with the cost object , the company must also determine the basis on which it would allocate the cost. This basis could be the number of hours, area, headcount, and more. For example, if headcount is the basis of allocation for insurance costs and a company has 500 employees, then the department with 100 employees will account for 20% of the insurance cost. Experts recommend choosing a cost allocation base that is a crucial cost driver as well.

A cost driver is a variable whose increase or decrease leads to an increase or decrease in the cost as well. For instance, the number of purchase orders could be a cost driver for the cost of the purchasing department.

An accountant may create many categories to pool costs, which are to be allocated subsequently. It is the account head where the costs should be accumulated before assigning them to the cost objects. Cost pools can be insurance, fuel consumption, electricity, rent, depreciation, etc. The selection of the cost pool primarily depends on the use of the cost allocation base.

Continue reading – Costing Terms .

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• Cost Structure
• Types of Costs and their Classification
• Cost Accounting and Management Accounting
• Types of Cost Accounting
• Cost Accumulation: Meaning, Types, and More
• Types of Costing

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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What is Cost Assignment?

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Cost assignment.

Cost assignment is the process of associating costs with cost objects, such as products, services, departments, or projects. It encompasses the identification, measurement, and allocation of both direct and indirect costs to ensure a comprehensive understanding of the resources consumed by various cost objects within an organization. Cost assignment is a crucial aspect of cost accounting and management accounting, as it helps organizations make informed decisions about pricing, resource allocation, budgeting, and performance evaluation.

There are two main components of cost assignment:

• Direct cost assignment: Direct costs are those costs that can be specifically traced or identified with a particular cost object. Examples of direct costs include direct materials, such as raw materials used in manufacturing a product, and direct labor, such as the wages paid to workers directly involved in producing a product or providing a service. Direct cost assignment involves linking these costs directly to the relevant cost objects, typically through invoices, timesheets, or other documentation.
• Indirect cost assignment (Cost allocation): Indirect costs, also known as overhead or shared costs, are those costs that cannot be directly traced to a specific cost object or are not economically feasible to trace directly. Examples of indirect costs include rent, utilities, depreciation, insurance, and administrative expenses. Since indirect costs cannot be assigned directly to cost objects, organizations use various cost allocation methods to distribute these costs in a systematic and rational manner. Some common cost allocation methods include direct allocation, step-down allocation, reciprocal allocation, and activity-based costing (ABC).

In summary, cost assignment is the process of associating both direct and indirect costs with cost objects, such as products, services, departments, or projects. It plays a critical role in cost accounting and management accounting by providing organizations with the necessary information to make informed decisions about pricing, resource allocation, budgeting, and performance evaluation.

Example of Cost Assignment

Let’s consider an example of cost assignment at a bakery called “BreadHeaven” that produces two types of bread: white bread and whole wheat bread.

BreadHeaven incurs various direct and indirect costs to produce the bread. Here’s how the company would assign these costs to the two types of bread:

• Direct cost assignment:

Direct costs can be specifically traced to each type of bread. In this case, the direct costs include:

• Direct materials: BreadHeaven purchases flour, yeast, salt, and other ingredients required to make the bread. The cost of these ingredients can be directly traced to each type of bread.
• Direct labor: BreadHeaven employs bakers who are directly involved in making the bread. The wages paid to these bakers can be directly traced to each type of bread based on the time spent working on each bread type.

For example, if BreadHeaven spent $2,000 on direct materials and $1,500 on direct labor for white bread, and $3,000 on direct materials and $2,500 on direct labor for whole wheat bread, these costs would be directly assigned to each bread type.

• Indirect cost assignment (Cost allocation):

Indirect costs, such as rent, utilities, equipment maintenance, and administrative expenses, cannot be directly traced to each type of bread. BreadHeaven uses a cost allocation method to assign these costs to the two types of bread.

Suppose the total indirect costs for the month are $6,000. BreadHeaven decides to use the number of loaves produced as the allocation base , as it believes that indirect costs are driven by the production volume. During the month, the bakery produces 3,000 loaves of white bread and 2,000 loaves of whole wheat bread, totaling 5,000 loaves.

The allocation rate per loaf is:

Allocation Rate = Total Indirect Costs / Total Loaves Allocation Rate = $6,000 / 5,000 loaves = $1.20 per loaf

BreadHeaven allocates the indirect costs to each type of bread using the allocation rate and the number of loaves produced:

• White bread: 3,000 loaves × $1.20 per loaf = $3,600
• Whole wheat bread: 2,000 loaves × $1.20 per loaf = $2,400

After completing the cost assignment, BreadHeaven can determine the total costs for each type of bread:

• White bread: $2,000 (direct materials) + $1,500 (direct labor) + $3,600 (indirect costs) = $7,100
• Whole wheat bread: $3,000 (direct materials) + $2,500 (direct labor) + $2,400 (indirect costs) = $7,900

By assigning both direct and indirect costs to each type of bread, BreadHeaven gains a better understanding of the full cost of producing each bread type, which can inform pricing decisions, resource allocation, and performance evaluation.

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What is Cost Allocation? Definition & Process

Jul 16, 2020 Michael Whitmire

Working with the former accountants now working at FloQast, we decided to take a look at some of the pillars of the accounting professions.

The key to running a profitable enterprise of any kind is making sure that your prices are high enough to cover all your costs — and leave at least a bit for profit. For a really simple business — like the proverbial lemonade stand that almost every kid ran — that’s pretty simple. Your costs are what you (or your parents) paid for lemons and sugar. But what if it’s a more complex business? Then you might need to brush up on cost accounting, and learn about allocation accounting . Let’s walk through this using the hypothetical company, Lisa’s Luscious Lemonade. 

What is cost allocation ?

The cost allocation definition is best described as the process of assigning costs to the things that benefit from those costs or to cost centers . For Lisa’s Luscious Lemonade, a cost center can be as granular as each jug of lemonade that’s produced, or as broad as the manufacturing plant in Houston. 

Let’s assume that the owner, Lisa, needs to know the cost of a jug of lemonade. The total cost to create that jug of lemonade isn’t just the costs of the water, lemons, sugar and the jug itself, but also includes all the allocated costs to make it. 

Let’s start by defining some terms…

Direct costs are costs that can be traced directly to the product or service itself. For manufacturers, these consist of direct materials and direct labor. They appear in the financial statements as part of the cost of goods sold .

Direct materials are those that become an integral part of the finished product. This will be the costs of the water, sugar, lemons, the plastic jug, and the label. 

Direct labor includes the labor costs that can be easily traced to the production of those finished products. Direct labor for that jug will be the payroll for the workers on the production line. 

Indirect costs are the costs that can’t be easily traced to a product or service but are clearly required for making whatever an enterprise sells. This includes materials that are used in such insignificant quantities that it’s not worth tracing them to finished products, and labor for employees who work in the factory, but not on the production line. 

Overhead costs encompass all the costs that support the enterprise that can’t be directly linked to making the items that are sold. This includes indirect costs , as well as selling, marketing, administration, and facility costs. 

Manufacturing overhead includes the overhead costs that are directly related to making the products for sale. This includes the electricity, rent, and utilities for the factory and salaries of supervisors on the factory floor. 

Product costs are all the costs in making or acquiring the product for sale. These are also known as manufacturing costs or total costs . This includes direct labor, direct materials, and allocated manufacturing overhead. 

What is the process?

The first step in any cost allocation system is to identify the cost objects to which costs need to be allocated. Here, our cost objec t is a jug of lemonade. For a more complex organization, the cost object could be a product line, a department, or a branch. 

Direct costs are the simplest to allocate. Last month, Lisa’s Luscious Lemonades produced 50,000 gallons of lemonade and had the following direct costs:

                                    Total costs     Cost per gallon Direct materials        $142,500               $2.85 Direct labor                   $37,500                   $.75

How are costs allocated?

Allocating overhead costs is a bit more complex. First, the overhead costs are split between manufacturing costs and non-manufacturing costs. Some of this is pretty straightforward: the factory floor supervisor’s salary is clearly a manufacturing cost, and the sales manager’s salary is a non-manufacturing cost. But what about the cost of human resources or other service departments that serve all parts of the organization? Or facilities costs, which might include the rent for the building, insurance, utilities, janitorial services, and general building maintenance?

Human resources and other services costs might be logically split based on the headcount of the manufacturing versus non-manufacturing parts of the business. Facilities costs might be split based on the square footage of the manufacturing space versus the administrative offices. Electricity usage might be allocated on the basis of square footage or machine hours , depending on the situation. 

Let’s say that for Lisa’s Luscious Lemonades, after we split the overhead between manufacturing and non-manufacturing costs, we have the following annual manufacturing overhead costs : 

Supervisor salary                                  $84,000 Indirect costs                                         $95,000 Facility costs                                           $150,000 Human resources                                  $54,000 Depreciation                                          $65,000 Electricity                                                $74,000 Total manufacturing overhead             $522,000

In a perfect world, it would be possible to keep an accurate running total of all overhead costs so that management would have detailed and accurate cost information. However, in practice, a predetermined overhead rate is used to allocate overhead using an allocation base . 

This overhead rate is determined by dividing the total estimated manufacturing overhead by the estimated total units in the allocation base . At the end of the year or quarter, the allocated costs are reconciled to actual costs. 

Ideally, the allocation base should be a cost driver that causes those overhead costs . For manufacturers, direct labor hours or machine-hours are commonly used. Since Lisa only makes one product — gallon jugs of lemonade — the simplest cost driver is the number of jugs produced in a year. 

If we estimate that 600,000 gallons of lemonade are produced in a year, then the overhead rate will be $522,000 / 600,000 = $.87 per gallon.

Our final cost to produce a gallon of Lisa’s Luscious Lemonade is as follows:

Direct materials                             $2.85 Direct labor                                     $0.75 Manufacturing overhead               $0.87 Total cost                                         $4.47

What is cost allocation used for?

Cost allocation is used for both external reporting and internally for decision making. Under generally accepted accounting principles (GAAP), the matching principle requires that expenses be reported in the financial statements in the same period that the related revenue is earned. 

This means that manufacturing overhead costs cannot be expensed in the period incurred, but must be allocated to inventory items, where those costs remain until the inventory is sold, when overhead is finally expensed as part of the cost of goods sold. For Lisa’s Luscious Lemonade, that means that every time a jug of lemonade is produced, another $4.47 goes into inventory. When a jug is sold, $4.47 goes to the cost of goods sold. 

However, for internal decision-making, the cost allocation systems used for GAAP financials aren’t always helpful. Cost accountants often use activity-based costing , or ABC, in parallel with the cost allocation system used for external financial reporting . 

In ABC, products are assigned all of the overhead costs that they can reasonably be assumed to have caused. This may include some — but not all — of the manufacturing overhead costs , as well as operating expenses that aren’t typically assigned to products under the costing systems used for GAAP. 

AutoRec to keep you sane

Whatever cost accounting method you use, it’s going to require spreadsheets that you have to reconcile to the GL. Combine that with the other reconciliations you have to do to close out the books, and like Lisa’s controller, you might be ready to jump into a vat of lemonade to drown your sorrows. 

Enter FloQast AutoRec. Rather than spend hours every month reconciling accounts, AutoRec leverages AI to match one-to-one, one-to-many, or many-to-many transactions in minutes. Simple set up means you can start using it in minutes because you don’t need to create or maintain rules. Try it out, and see how much time you can save this month. 

Ready to find out more about how FloQast can help you tame the beast of the close?

Michael Whitmire

As CEO and Co-Founder, Mike leads FloQast’s corporate vision, strategy and execution. Prior to founding FloQast, he managed the accounting team at Cornerstone OnDemand, a SaaS company in Los Angeles. He began his career at Ernst & Young in Los Angeles where he performed public company audits, opening balance sheet audits, cash to GAAP restatements, compilation reviews, international reporting, merger and acquisition audits and SOX compliance testing. He holds a Bachelor’s degree in Accounting from Syracuse University.

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• Cost Classifications
• Relevant Cost of Material
• Manufacturing Overhead Costs
• Conversion Costs
• Quality Costs
• Revenue Expenditure
• Product Cost vs Period Cost
• Direct Costs and Indirect Costs
• Prime Costs and Conversion Costs
• Relevant vs Irrelevant Costs
• Avoidable and Unavoidable Costs
• Cost Allocation
• Joint Products
• Accounting for Joint Costs
• Service Department Cost Allocation
• Repeated Distribution Method
• Simultaneous Equation Method
• Specific Order of Closing Method
• Direct Allocation Method

Cost allocation is the process by which the indirect costs are distributed among different cost objects such as a project, a department, a branch, a customer, etc. It involves identifying the cost object, identifying and accumulating the costs that are incurred and assigning them to the cost object on some reasonable basis.

Cost allocation is important for both pricing and planning and control decisions. If costs are not accurately calculated, a business might never know which products are making money and which ones are losing money. If cost are mis-allocated, a business may be charging wrong price to its customers and/or it might be wasting resources on products that are wrongly categorized as profitable.

Cost allocation is a sub-process of cost assignment , which is the overall process of finding total cost of a cost object. Cost assignment involves both cost tracing and cost allocation. Cost tracing encompasses finding direct costs of a cost object while the cost allocation is concerned with indirect cost charge.

Steps in cost allocation process

Typical cost allocation mechanism involves:

• Identifying the object to which the costs have to be assigned,
• Accumulating the costs in different pools,
• Identifying the most appropriate basis/method for allocating the cost.

Cost object

A cost object is an item for which a business need to separately estimate cost.

Examples of cost object include a branch, a product line, a service line, a customer, a department, a brand, a project, etc.

A cost pool is the account head in which costs are accumulated for further assignment to cost objects.

Examples of cost pools include factory rent, insurance, machine maintenance cost, factory fuel, etc. Selection of cost pool depends on the cost allocation base used. For example if a company uses just one allocation base say direct labor hours, it might use a broad cost pool such as fixed manufacturing overheads. However, if it uses more specific cost allocation bases, for example labor hours, machine hours, etc. it might define narrower cost pools.

Cost driver

A cost driver is any variable that ‘drives’ some cost. If increase or decrease in a variable causes an increase or decrease is a cost that variable is a cost driver for that cost.

Examples of cost driver include:

• Number of payments processed can be a good cost driver for salaries of Accounts Payable section of accounting department,
• Number of purchase orders can be a good cost driver for cost of purchasing department,
• Number of invoices sent can be a good cost driver for cost of billing department,
• Number of units shipped can be a good cost driver for cost of distribution department, etc.

While direct costs are easily traced to cost objects, indirect costs are allocated using some systematic approach.

Cost allocation base

Cost allocation base is the variable that is used for allocating/assigning costs in different cost pools to different cost objects. A good cost allocation base is something which is an appropriate cost driver for a particular cost pool.

T2F is a university café owned an operated by a student. While it has plans for expansion it currently offers two products: (a) tea & coffee and (b) shakes. It employs 2 people: Mr. A, who looks after tea & coffee and Mr. B who prepares and serves shakes & desserts.

Its costs for the first quarter are as follows:

Total tea and coffee sales and shakes sales were $50,000 & $60,000 respectively. Number of customers who ordered tea or coffee were 10,000 while those ordering shakes were 8,000.

The owner is interested in finding out which product performed better.

Salaries of Mr. A & B and direct materials consumed are direct costs which do not need any allocation. They are traced directly to the products. The rest of the costs are indirect costs and need some basis for allocation.

Cost objects in this situation are the products: hot beverages (i.e. tea & coffee) & shakes. Cost pools include rent, electricity, music, internet and wi-fi subscription and magazines.

Appropriate cost drivers for the indirect costs are as follows:

Since number of customers is a good cost driver for almost all the costs, the costs can be accumulated together to form one cost pool called manufacturing overheads. This would simply the cost allocation.

Total manufacturing overheads for the first quarter are $19,700. Total number of customers who ordered either product are 18,000. This gives us a cost allocation base of $1.1 per customer ($19,700/18,000).

A detailed cost assignment is as follows:

Manufacturing overheads allocated to Tea & Cofee = $1.1×10,000

Manufacturing overheads allocated to Shakes = $1.1×8,000

by Irfanullah Jan, ACCA and last modified on Jul 22, 2020

Related Topics

• Cost Behavior

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COST ASSIGNMENT Definition

COST ASSIGNMENT involves assigning costs of an account to the accounts that are responsible or accountable for incurring the cost. For example, the cost of issuing purchase orders is allocated to the various objects procured. The cost assignment is done through assignment paths and cost drivers. The assignment path identifies the source account (the account whose cost is being assigned "Issue Purchase Orders" in the above example) and destination accounts (the accounts to which the costs are being allocated the various cost objects procured by issuing purchase orders in the above example). The cost driver identifies the measure or rationale on the basis of which the assignment needs to be done, that is, whether the costs of issuing purchase orders need to be assigned to various cost objects evenly, based on some defined percentage values, or based on some criterion, like the number of purchase orders of each cost object issued. Defining the cost drivers and assignment paths (i.e., source and destination accounts) enable proper assignment and accounting of the various costs incurred in the organization.

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Module 6: Process Costing

Introduction to accumulating and assigning costs, what you will learn to do: assign costs to various stages of production.

Here is an overview of what you will learn in detail in this section:

You can view the transcript for “Process Costing” here (opens in new window) .

There are two methods for using process costs: Weighted Average and FIFO (First In, First Out). Each method uses equivalent units and cost per equivalent units but calculates them just a little differently.

When you are done with this section, you will be able to:

• Prepare a production cost report for the first stage of a multi-step process using the weighted-average method
• Prepare a production cost report for a second or subsequent stage of a multi-step process using the weighted-average method
• Prepare a production cost report using the FIFO method

Learning Activities

The learning activities for this section include the following:

• Reading: First-stage production report
• Self Check: First-stage production report
• Reading: Subsequent-stage production report
• Self Check: Subsequent-stage production report
• Reading: Production report using FIFO
• Self Check: Production report using FIFO
• Introduction to Accumulating and Assigning Costs. Authored by : Joseph Cooke. Provided by : Lumen Learning. License : CC BY: Attribution
• Process Costing. Authored by : Edspira. Located at : https://youtu.be/guZc84c5HNI. . License : All Rights Reserved . License Terms : Standard YouTube License

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Mobility Basics: Cost estimates

It is no secret that international assignments and even permanent transfers can be very expensive, but does your organisation know just how much they are costing? Monitoring and controlling the costs of assignments are both consistently a major concern for global mobility (GM) teams and their organisations – in fact, more than half of companies participating in our latest Managing Mobility Survey reported that these are currently significant challenges for them. 

Why undertake a cost estimate?

Cost estimates enable companies to determine how much potential international moves will likely cost before they begin. This insight is indispensable to different stakeholders across the business and is used for a range of purposes:

Improving management approval workflow

Decision makers use cost estimates to assess whether a given assignment or permanent relocation is worth the significant investment and to reduce the chance of unpleasant surprises further down the line. Companies may therefore choose to incorporate the preparation and sign-off of a cost estimate in their standard assignment process. 

For the business unit bearing the expense, knowing the expected cost of an assignment means that it can be incorporated into its budget.

Evaluating different scenarios

Companies are more likely than ever before to use a greater variety of international move types, and GM teams can use cost estimates to evaluate and compare different scenarios. Traditional long-term assignments remain popular, but in some cases short-term assignments and permanent relocations are attractive alternatives. Even for long-term assignments, there are different types when it comes to pay – it can be calculated based on a home salary starting point (i.e. the salary for the equivalent job in the home country) or a host salary (i.e. the local market rate in the host country). Some use the cost estimates to make comparisons between the cost of continued employment in the home location and the cost of an assignment. With many organisations having a stronger focus on the bottom line, looking at the different possible scenarios in advance can be a useful tool when GM is seeking management buy-in.

Designing and maintaining a business-enabling GM programme

One of the key purposes of a GM programme is business enablement. Being able to accurately project costs to support the business in their daily operations will help GM managers demonstrate the value of their programme.

Producing project bids

Many companies, particularly those in the construction and energy sectors, need to tender for projects that will require international assignments. Estimating labour costs is usually an important part of how companies’ bid teams calculate rates and safeguard margins.

What is included in a cost estimate?

Typically, costs are split into four components: salary, annual benefits, one-off relocation costs, and tax and social security liabilities:

For any type of assignment, salary and bonus payments make up a large part of the total costs. Where the assignee is entitled to additional allowances and pay adjustments as part of their assignment salary, these amounts are taken into account. Cost of living adjustments (i.e. COLAs) are usually provided for long-term assignments where the package is home-based, whereas an allowance to cover daily essentials is typical for a short-term assignment. Assignment allowances and location allowances are also often given. When the salary is host-based – and this could be the case for either a long-term assignment or a permanent transfer – then the gross salary to be paid in the host location is usually all that needs to be considered (and any bonus payments).

On top of salary, other annual costs need to be considered as well. These are made up of ongoing benefits provided during the assignment (or, for permanent transfers, benefits provided during the first year). Accommodation is usually the largest expense; in some locations, this cost can even exceed the cost of the salary. Other benefits that may be included are utilities, education costs for children, a company car, home leave, medical insurance and annual tax return preparation – and the costs incurred will depend on the assignee’s destination and the size of the relocating family. While the benefits provided will vary from one move type to another, this component still increases the package significantly.

Most companies also factor in the one-time costs incurred at the start of a move (and at repatriation in the case of assignments). Some of the more significant costs relate to the physical act of relocating an employee and their family to another location. As with the annual costs, costs for flights, shipment of personal effects, temporary accommodation, and other similar expenditure will vary considerably depending on the circumstances of the assignee and the locations between which they will travel. The relocation costs of repatriating should also be considered for assignments, though these will of course not apply for permanent transfers.

Tax and social security

Finally, on top of salary payments, annual and one-time costs, the thorny issues of tax and social security must be considered. Together these have the potential to make up a substantial proportion of the overall cost of a move. The elements of the package that are taxable and the rates at which they are taxed will vary depending on each host location’s fiscal law. When an assignee’s pay is home-based – for either a long-term or short-term assignment – their package is normally tax equalised. Their salary, benefits and relocation costs are quoted net and the company meets the income tax and social security contributions (employee and employer) incurred on these. When an employee is quoted a gross host salary for a long-term assignment, the employer usually still pays any tax that arises on move-related allowances, benefits, and relocation support. In permanent transfer cases, normally the employee is quoted a gross host salary and required to pay any tax that arises on the additional benefits and relocation support provided, with the employer required to pay social security contributions due on the package.

The benefits of cost estimates

Improving cost awareness and control

Making cost estimates an integral part of the mobility process improves cost awareness and control. Often the only part of the business with a good idea of the total costs of an assignment is the GM team. Cost estimates allow better communication of these costs to relevant stakeholders in a clear and accessible way. This greater awareness inevitably improves cost control; faced with information on the significant outlay, the business unit bearing the cost will see it needs to be justified by a clear business rationale if the assignment is to go ahead. 

Cost reduction

Going further than cost control, if cost reduction is a priority, then demonstrating the full costs to the business can encourage the implementation of more stringent approval requirements for assignments. Being able to compare various scenarios will also enable the business to select the most cost-efficient move type. Where a choice of the assignment location is an option, a cost estimate will provide clarity on where to base the assignee.

Cost estimates are a valuable resource for GM teams looking to increase cost awareness and control by providing a clear picture of the costs involved in running their company’s global mobility programme. This insight can be hugely advantageous for business decision making and strategy and raising the profile of GM within the organisation.  

Software specifically designed for running cost estimate calculations saves considerable time, reduces the risk of human error and provides clear and attractive outputs.

ECA’s Cost Estimate Calculato r provides you with an accurate picture of the overall cost of your international moves, simply and quickly. This intuitive tool offers instant access to cost estimates, and is easy to use by mobility teams and non-specialists alike. It comes pre-populated with ECA’s robust tax and global mobility data and pre-programmed to best practice settings. You can run a solid estimate for the overall assignment costs in less than a minute for any of four different move types – long-term (home- or host-based), short-term and permanent – making it easy to compare options. Watch this 15-minute demo to see for yourself how quick and powerful the tool is*.

Do you need a bespoke or integrated solution? Speak to a member of our team to find out more about your options. Our Assignment Management System, ECAEnterprise , can support you through the entire assignment lifecycle and is tailored to your specific requirements, including customised cost estimate rules.

Alternatively, tailored cost estimate calculations can be bought on demand through our Consultancy and Advisory service.

*Please note, you will need to sign in to MyECA to access the demo. If you don't yet have a MyECA account, it only takes a few minutes to sign up .