Cost Allocation

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Cost Allocation
April 23, 2012

Cost Allocation
The purpose of cost allocation is to identify and correctly allocate costs associated with a job, product, or service. The main uses of cost allocation are to facilitate decision-making regarding costs, justify prices charged for products and services, cost control, and for optimal utilization of resources. There are several methods used for cost allocation, depending on the type of product or service offer by the company.
Variable cost allocation includes only variable manufacturing costs, such as direct materials, direct labor, and variable manufacturing overhead. Absorption cost allocation includes manufacturing costs, including both variable and fixed overhead as
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The Step method of cost allocation, allocates costs between service departments in steps, starting with the service department that provides the most service to the other service departments. After this allocation takes place, the next step in the process allocates costs to the department that provides the next most service. This keeps stepping down until all costs have been allocated between service departments (Accounting For Management, 2012).
The Reciprocal method of allocating costs takes into account all activity between both interdepartmental service departments and operational departments. For instance, the custodial department services both the mail room and the manufacturing department. The cost of the portion of custodial service provided to the mailroom would be allocated directly to the mailing department, and cost of the portion of custodial service provided to the manufacturing department would be allocated directly to the manufacturing department. Unlike the step method that only allocates forward from the service departments providing the most service to those providing least, the reciprocal method can work backward. At the same time costs of the custodial department are being allocated to the mail room (because of the mail room being cleaned), the mail room will allocate costs to the custodial department for the mail that needs to be picked up and delivered there. Thus, reciprocal activity is
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