Cost Accumulation and Allocation

Cost Accumulation, Tracing, and Allocation

• Cost accumulation begins with identifying cost objects.
• The primary cost object is the cost of a promotion, and secondary cost objects would include cap costs, advertising costs, and labor costs.
• These secondary cost objects are combined to determine the primary cost object's cost.

Key Concepts

• Cost Accumulation: Collecting and summarizing costs of a cost object.
• Cost Drivers & Cost Objects: Cost drivers are factors that directly affect costs (e.g., number of caps produced, number of advertisements, employee hours spent on a promotion). Costs objects are the things for which the cost is desired (e.g., a promotion).
• Cost Allocation: Assigning costs that can't be directly traced to a specific object to multiple cost objects.

Why Use Costing?

• Managers need reliable costs to price products and services, evaluate performance, control operations, and prepare financial statements.
• Cost objects are the items for which a cost is determined.

Determine the Cost of Cost Objects

• Accountants use cost accumulation to find out the costs associated with specific items or activities.
• An example is a promotion where free baseball caps are given to attendees.
• Three cost components of this promotion are the caps' cost, advertising cost, and employee work cost.

Cost Allocation Process

• This process involves dividing a cost into parts, then allocating them to specific cost objects (e.g., departments).
• A crucial first step is identifying the cost driver (e.g., store size drives rent cost).
• This helps with a rational allocation of the cost using a two-step process: 1. compute the allocation rate for the cost, and 2. multiply this rate by the amount of the cost driver.

Cost Allocation Template (Examples)

• Rent Allocation: Calculates the allocation rate for rent based on total costs to be allocated and the total square footage. Allocates the rent cost based on the square footage for each department.
• Utilities Allocation: Based on total utilities cost to be allocated divided by total square footage. Allocates the utility costs based on the square footage for each department.
• Supplies Allocation: Calculates the allocation rate of costs based on total supply costs and total sales. Allocates these costs to each department based on sales.

Cost Allocation - Additional Notes

• Companies often group similar costs into cost pools to simplify allocation.
• The best cost driver has the strongest cause-and-effect relationship with the cost being allocated.
• Selecting the right cost driver is critical to getting an allocation that accurately reflects how a cost is used, like linking shopping bags to the number of sales transactions or total sales amounts.
• Availability of information often influences cost driver selection.

Allocating Indirect Costs to Objects

• Common costs support multiple cost objects and are not traceable to any specific object (e.g., rent).
• Allocate common costs to departments to determine manager responsibilities for controllable costs (those easily influenced by managers' decisions).
• Cost/Benefit Considerations: Analyze if allocating a cost is more beneficial than not allocating.

Cost Classifications: Independent and Context Sensitive

• The classification of a cost as direct or indirect isn't dependent on whether it's fixed or variable.
• Costs like goods sold and supplies, while variable based on sales volume, are direct (for goods sold) and indirect (for supplies).
• Rental and depreciation are both fixed relative to sales volume, but rent is indirect, and depreciation is direct (depending on cost objects)

Cause-and-Effect Relationship

• A strong cause-and-effect relationship isn't always immediately obvious, necessitating careful consideration when choosing a cost driver.

Using Cost Allocations in Budgeting Decisions

• Using cost allocations is crucial when making decisions about budgets and management resources.

The Human Factor

• Cost allocations can affect individual's performance evaluations, compensation, and the resources various departments get.
• This impact can create potential issues, like motivating behavior in the wrong direction or introducing perceptions of unfairness.

Using Cost Drivers to Make Allocations

• The number of faculty members can be used as a cost driver for allocating copying costs in a budgeting decision.

Choosing the Best Cost Driver and Controlling Emotions

• Determining the most accurate cost driver involves judgment and careful consideration of the interrelationships.

Cost Drivers for Variable Overhead Costs

• Volume measures (units produced, labor hours, materials used) are crucial for variable overhead cost allocation.

Cost Drivers for Fixed Overhead Costs

• Fixed costs do not commonly relate to the volume of production.
• The objective in allocating fixed costs is to fairly distribute overhead across products.
• Often, a fixed allocation base that distributes costs equally among all products is sufficient if no other cost driver is strongly related.

Allocating Fixed Overhead Costs

• Fixed costs are allocated based on a reasonable cost driver, like the volume of production.

Allocating Fixed Costs When the Volume of Production Varies

• Allocation rates needed will change when production volumes vary, complicating calculations.

Predetermined Overhead Rate

• Predefined rate calculation uses expected costs and production quantities.

Cost Allocation

• Cost allocation signifies dividing total costs into parts and then assigning these parts to cost objects, in this case, departments.

Cost Drivers for Variable Overhead Costs

• A cause-and-effect relationship exists between the variable overhead cost and the volume of production.
• Volume measures, like units produced, labor hours, and materials used, are effective cost drivers.

Using Units as the Cost Driver

• Using the number of units produced as a cost driver enables allocation of indirect materials costs to either desks or chairs.

Using Labor Hours as the Cost Driver

• Direct labor hours are relevant cost drivers for understanding how indirect materials are used (likely higher material use for desks than chairs due to the labor hours required).

Using Direct Hours Labor as the Cost Driver

• Costs are allocated based on the labor hours spent on desks versus on chairs.

Using Direct Materials Dollars as the Cost Driver

• Because material usage likely drives the need for indirect materials allocation, direct materials usage can be a good cost driver.