Chapter 7 - Cost allocation: Theory. The main contents of the chapter consist of the following: Definitions and glossary, steps of cost allocation, external cost-based contracts, pervasiveness of cost allocations, reasons to allocate costs, incentive/organizational reasons for cost allocations. | Cost Allocation: Theory Chapter Seven Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Connection of Cost Allocation to Other Chapters in this Book Chapter 2 (costing for decision making): Cost allocations might be used as proxies for opportunity costs. Chapter 4 (organizational architecture): Cost allocations are a form of transfer pricing and are useful for control. Chapter 5 (responsibility centers): Cost allocations influence decision rights and performance measurement. Chapter 6 (budgeting): Cost allocations influence how resources are allocated within the firm. Chapter 8 discusses practical problems of cost allocation. Chapters 9 through 13 (product costing): Indirect manufacturing costs are allocated to products. 7- Definitions and Glossary Cost object is a product, process, department, or program that managers wish to cost. Common cost is a cost shared by two or more cost objects. Examples: Accounting, building maintenance, supervisors. Cost allocation is the assignment of indirect, common, or joint costs to cost objects. Allocation base is the measure of activity used to allocate costs. Examples: hours, floor space, sales dollars. 7- Steps of Cost Allocation 1. Defining the cost objects. Decide what departments, products, or processes to cost. 2. Accumulating the common costs to be assigned to the cost objects. (Also known as indirect cost pools.) 3. Allocating the accumulated costs to cost objects using an allocation base. (Also known as cost assignment, apportionment, or distribution.) Usually the allocation base approximates how the cost objects consume common resources. See Self-Study Problem. 7- External Cost-based Contracts Usage: Some organizations purchased goods and services with cost-based contracts. Suppliers were paid for their reported costs plus a stated profit percentage. Examples: Military aircraft, hospital services, university research grants. Incentives: Contractors maximize the . | Cost Allocation: Theory Chapter Seven Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Connection of Cost Allocation to Other Chapters in this Book Chapter 2 (costing for decision making): Cost allocations might be used as proxies for opportunity costs. Chapter 4 (organizational architecture): Cost allocations are a form of transfer pricing and are useful for control. Chapter 5 (responsibility centers): Cost allocations influence decision rights and performance measurement. Chapter 6 (budgeting): Cost allocations influence how resources are allocated within the firm. Chapter 8 discusses practical problems of cost allocation. Chapters 9 through 13 (product costing): Indirect manufacturing costs are allocated to products. 7- Definitions and Glossary Cost object is a product, process, department, or program that managers wish to cost. Common cost is a cost shared by two or more cost objects. Examples: Accounting, building maintenance, .
