Summary management accounting ch12

Chapter 12; cost allocation



[LO 1] Cost allocation methods comprise an important part of a company’s cost accounting system to
determine the cost of a certain cost object.

Less than half of most companies’ operating costs can be traced directly to products and services.
The rest of a company’s costs must be allocated using a cost-allocation base or left unallocated.

After developing a general framework for cost allocation, companies assign costs to cost objectives.
There are four types of cost objectives:

 Service departments
 Producing departments
 Products/services
 Customers



The cost accounting system first accumulates costs and assigns them to organizational units, which
are also called departments. There are two types of departments:

1. Producing departments
a. Where employees work on the organization’s products and services
2. Service departments
a. Which only exists to support other departments or customers

Direct costs can be directly traced to different departments. Indirect costs must be allocated. Many
companies develop allocation methods to assign service department costs to the producing
departments.

[LO 2] SKIPPED BY POWERPOINT. DO NOT STUDY.



[LO 3] Direct and step down methods

Service departments often support other service departments in addition to the producing
departments they support. There are two main methods for allocating service department costs:

1. The direct method
2. The step down method



The direct method:

The direct method ignores other service departments when any given service department’s costs are
allocated to the producing departments.

Example:

You have two service departments. HR($240,000) and service($1,260,000). And two producing
departments; A(15,000m^2) and B(3,000m^2). First you divide $240,000 over both based on their