Methods of Cost Allocation:
There are two basic departments in a manufacturing company; one is production department and the other is service department. Allotment of service department cost to production department (methods of cost allocation) is a very interesting concept to measure the cost (value) of different commodities used in manufacturing process. Cost allocation method is a way to evaluate profit. To understand the concept, we must know about the production costs center and service cost center.
Production cost centers are directly involved in the production process as changing the shape of the material on worked upon, or just assembling the parts into a finished product. Typical examples of producing departments include cutting, stitching, spinning, assembly, weaving or etc.
Service cost centers refer to those costs that produce nothing but indirectly help in production by providing services to production cost centers. In certain cases service departments render services not only to the producing departments but also to other service departments. Typical examples of service departments include maintenance, stores, canteen, personnel, etc.
Procedure in Cost Allocation:
As products are not processed in service departments, their costs cannot be charged directly to products or cost units. Firstly cost of service departments are built up by the usual process of allocation and primary apportionment. Afterwards their costs are allotted to production cost centers on some equitable or fair basis according to the use which producing departments make of service departments. Lastly, after calculating overhead absorption rates, costs of producing departments (including their share in the costs of service departments) are charged to jobs or products.
|Service Departments||Basis of Apportionment to Cost Centers|
|Canteen, personnel, inspection, medical||Number of workers|
|Stores||Number of store requisitions|
|Maintenance||Number of maintenance hours/value of asset subject to maintenance|
All efforts are made to charge service department overheads to the production departments on the basis of records kept by service departments of their work done for the production departments. For example, maintenance work undertaken for a production department, then the costs incurred on maintenance would be charged to the concerned production department.
There are following types of cost allocation methods: