Question

The question of allocating costs is widely discussed. What are some of the reasons for the allocation of costs? It takes time, and thus money [incurring its own costs], so does the cost allocation benefit outweigh the cost? Well, if so, how?

Answer 1

What are some of the reasons for the allocation of costs?

Direct material cost and direct labor cost can be traced to products/services. But, common manufacturing costs [manufacturing overheads] cannot be so traced to products/services. Then the need arises for allocating them to products/services.

In some situations, though costs are traceable, the costs of tracing them may not be worth the benefit derived from such tracing. In such cases also, costs can be allocated. An example of such direct cost whcih, is not traced are nails and screws of furniture manufacturers. They can be allocated along with overheads.

It takes time, and thus money [incurring its own costs], so does the cost allocation benefit outweigh the cost? Well, if so, how?

Allocation if done properly, would yield benefits that would outweigh the costs of such allocation.

Selecting appropriate bases and collection of overhead costs in a manner that facilitates proper allocation using the bases selected, will help in proper ascertainment of cost of manufacture. The benefits would be:

*rational determination of costs that will aid decision making, like pricing, product mix selection, etc.

*planning and control of overhead costs.

*elimination of non-value adding activities, through Activity Based Cost allocation.