Cost allocation method

Using the example given above, let us assume that the HR department hired 3 staff members for product A and 7 staff members for product B. Machine time. In turn, the associated expense is assigned to internal clients' cost centers that consume the products and services.

These operating departments perform the primary purpose of the company—to produce goods and services for consumers.

Indirect cost allocation methods

Required: Allocate the cost of service departments to operating departments using direct method of cost allocation. In first step, the cost of department A has been allocated to other service department department B as well as to operating departments department X and Y. Consequently, it is best to use the simplest method available, and not worry about a high level of allocation precision. We continue this step down method until all the costs have been allocated to the products. Another concern is that square footage is only two dimensional. Thus, in the African Bongo Corporation example above, the company could forbear from allocating the cost of its power station, on the grounds that none of the six operating departments have any control over the power station. Learn how and when to remove this template message Cost allocation is a process of providing relief to shared service organization's cost centers that provide a product or service. It begins with the allocation of cost of the service department that provides the greatest amount of service to other service departments and ends with the allocation of cost of the service department that provides the least amount of service to other service departments. Another favorite is cost allocations based on the amount of machine time used by a product. The cost allocation under step method is a sequential process. March 19, by Brigitta Schwulst Keeping track of costs is an essential part of running a business. Costs are not allocated back to a department that has already had all of its costs allocated. This method allocates all the service department costs to the production department and does not take into account that the service department offers services to other departments.

For the purposes of our example, we will rank the HR department as the top department and the maintenance department as the second department.

This is an easy calculation, for there is usually an industrial engineering standard already in place that documents the amount of direct labor associated with a product. Another concern is that square footage is only two dimensional. Since high sales volume does not necessarily equate to high profitsthis approach can result in a low-profit entity being burdened with a substantial corporate allocation.

Any profit generated by the departments contributes toward paying for the unallocated cost. Under this method, the costs incurred by service departments are not allocated to each other; rather, they are directly allocated to operating departments using some appropriate allocation base.

The cost allocation under step method is a sequential process. Examples of service departments are maintenance, administration, cafeterias, laundries, and receiving.

why is cost allocation important

However, the amount of direct labor consumed may be far smaller than the amount of factory overhead, which can result in large allocations based on small amounts of direct labor cost.

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Allocation of Service Department Costs