Dr. George Gekas Notes

These notes are posted on blackboard to high light and complement certain aspects of the topic, facilitate those students who may have missed my lecture, balance traditional with internet based learning and overall enhance student’s learning.. The notes are not meant to suggest what may be in the exams, replace textbook studying and/or problem solving.

WHAT IS ALL ABOUT?

Cost allocation deals with one of the following large areas:

1. How should fixed or overhead costs be allocated to different departments or products? 2. How should costs of shared services be allocated among various departments? 3. How should joint (common) costs of a single production process be allocated to products that emerge from this joint process?

TERMINOLOGY USED:

Cost allocation
Cost assignment
Cost apportionment
Cost distribution
Cost application
Cost tracing

REASON FOR COST ALLOCATION:

1. To establish cost 2. To price inventories 3. To establish the right price, what price to charge (Pricing decision). 4. To determine accurately net profit (Price-cost) 5. To motivate managers/ employees to decrease overhead cost, and to encourage production and other designs less costly to service 6. To evaluate performance of different departments 7. To allocate overall capacity among different products, or to assist in the decision to add / delete a product or department.

THEORETICAL CRITERIA FOR COST ALLOCATION

1. Cause and effect criterion Example: Insurance premium depends on asset value. The higher the asset value the higher the premium. It is easy to establish a cause and effect relationship for variable costs but not as easy for fixed costs.

2. Ability to bear (affordability) Example: Subsidized day care centers charge according to the parent’s level of income This is a somewhat arbitrary