Cost Allocation

Cost allocation refers to a process that attributes costs to particular cost centers.  It includes the process of identifying and assigning the costs of services necessary for the operation of a business or other type of entity. Let us assume that the wage of the driver of the purchasing department can be allocated to the purchasing department cost centre. It does not necessarily have to share the wage cost over several different cost centers. Cost and services in this case are not identical to each other.

Cost allocation is also referred to as the assigning of a common cost to several cost objects. If a company allocates or assigns the cost of an expensive computer system to the three main areas of the company that use the system. For example a company with a single electric meter might allocate the electricity bill to several departments in the company. The cost allocation is not much concerned with the actual amount of the cost, and more concerned with allocating or assigning the cost to the correct unit within the organization.  

Cost allocation is a tool that helps track all costs associated with the ongoing operation more efficiently, since each cost is associated with specific departments or groups of departments within the organization.  There are a variety of cost allocation methods. The various methods are the direct method, the reciprocal method and the step-down method

There are three aspects of cost allocation. First aspect involves the choosing the object of costing. Examples of this are products, processes, jobs, or departments. Secondly choosing and accumulating the costs that relate to the object of costing. Examples included in this aspect are manufacturing expenses, selling and administrative expenses, joint costs, common costs, service department costs, and fixed costs; and thirdly choosing a method of identifying first with second aspect. A cost allocation base is used for allocating manufacturing costs would typically be labor-hours, machine-hours, or production units.

Questions

• What is a cost allocation?
• What are the aspects of a cost allocation?