Cost Allocation Strategies for Efficient Decision-Making

1. Chapter 35 Activity Based Systems Prepared by Diane Tanner University of North Florida

2. GAAP requires full cost information To make decisions of pricing, expansion, product dropping, cost-plus contracts, etc. Make managers conserve resources Create incentives for evaluating efficiency of ‘fee’ based company services Why Do We Allocate Costs? 2

3. Three Steps Identify the cost objects Form cost pools Select an activity base that best drives the cost pools Cost Allocation Process 3

4. What is a Cost Object? 4 • A product, job, service provided, batch, or department that will receive a portion of a cost allocation • Somethingfor which we want to know its cost

5. What is a Cost Pool? 5 • A grouping of individual costs whose total is allocated using one allocation base • Often based on departments • Usually consists of both variable and fixed costs • Sometimes called a cost bucket

6. An activity that causes the cost pool to increase Often called a cost driver because more of the activity ‘drives’ a cost up What is an Activity Base? 6 # of DL Hours # of Customers # of packages Products Activity Bases Amt. of DL$ # of Employees Cost Objects # Sq. Feet # of Customers # of Inspections

7. Problem: Identifying a relationship with indirect fixed costs is not feasible Criteria Used When Selecting Allocation Bases 7 Possible Criteria Goal of Allocation Base Relative Benefits • To allocate more costs to the cost objectives that benefit most from incurring the cost • To allocate more costs to most profitable products • To allocate fairly and equitably Ability to Bear Costs Equity

8. The End