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A companys research and development wing equipments are
used to create innovations, administration spends on special task
forces to complete a series of unusual assaults on the city, and
company uses machines to manufacture two different products.
So the question arises that how the cost are being allocated to
every department or every product so that it becomes easy for
decision making in future. University presidents, city managers
and company board of directors each has to face similar cost
allocation problems. So this report is on the cost allocation part
of managerial accounting.
Goal of cost accounting :
It measures the cost of designing, developing, producing,
selling, distributing, and servicing particular products or
services. Cost accounting is the heart of the accounting systems.
Its three main purposes are
1. To obtain desired motivations : Cost accounting are usually
made to influence management behaviours and top level
decision makings to promote goal congruence and
managerial efforts.
2. To compute income and asset valuations : Costs are
allocated to products to measure various aspects such as
overheads associated, inventory costs, cost of goods sold,
etc. However these costs are exploited by managers to
evaluate performance, to foster employees and to plan for
the future.
3. To justify costs or obtain reimbursement: Occasionally cost
directly influence price. So the cost allocation generates an
alternative for setting the price in usual market places.
So the processes involved in cost allocation are

1. Identifying Cost Objects : It is the cost of the objects which
we want to know the cost of. Eg : services or a product.
Cost objects co notates the batch production run in an
assembly line process or a one day production in a
continuous manufacturing processes.
2. Identify Direct Costs : Direct costs are directly attached to
the unit under consideration and can be easily traced to
Identify Cost Objects
Identify Direct Costs
Identify Overhead Costs
Select Cost Allocation Base
Develop the overhead rates
specific products. These are also called Prime Costs. It can
be like direct labor or direct materials used up to obtain the
3. Overhead Costs : These are the costs that are related to the
cost objects but cannot be obtained easily in an
economically feasible way. These includes costs like
electricity cost, factory office salaries, building and
machine maintenance, depreciations or any indirect costs.
4. Select Cost Allocation Base : It is the link that is used to
associate overhead costs to the cost objects. It is very
important to identify allocation base as a varied range of
products are manufactured in an industry. Whatever cost
allocation base is chosen it must be a common denominator
across all cost objects.
5. Develop the Overhead Rates :
Overhead rates = (Overhead costs in the cost pool/ Total
quantity of the allocation base)
It represents amount of overhead costs allocated per unit of
allocation base.
So now we will consider a case of an apparel
manufacturing company which makes jeans and chinos.
Here we will understand that how important the above
processes are in the manufacturing sector and how it effects
the decision making of the managements

Assumptions made are as follows:

Cost allocations of jeans by XYZ in 2013 :

Cost allocation section wise in jeans :
Items Costs (all in $)
1. Raw materials for denim
fabrics(includes raw material+
movement of denim material
from receiving department to
the cutting room)
2. Work in process (to record
sewing operator wages)
3. Factory overheads(including
utilities, depreciations, repairs
and maintenance, and indirect
wages and salaries)
Total Cost 6620000
Inputs Cost per jeans(all in $)
Fabric 1 yard per jeans* $5 per yard=
Direct Labor .4 hours per jeans *$14 per
Overhead .4 hours per jean* $6.6 per hour=
Total cost per

Cost allocation of Chinos by XYZ in 2013 :
Items Costs(all in
1. Raw materials for cotton twill
fabrics(includes raw material+
movement of cotton twin material
from receiving department to the
cutting room)
= 2160000
2. Work in process (to record sewing
operator wages
300000*14 =
3. Factory overheads(including
utilities, depreciations, repairs and
maintenance, and indirect wages and
Total Cost 8340000

Cost allocation section wise for Chinos:

Input Costs per chinos (all in $)
Fabrics 1.2 per chinos * $4.5 per yard =
Direct Labor .75 hours per chinos * $14 per
hour = 10.50
Overhead .75 hours per chinos * $6.6 per
hour = 4.95
Total cost per

Conclusion :
Here the allocation base is direct labor hours. If the
allocation base had been something else such as machine
hours then hours per unit would only appear in the
calculation of the direct labor cost.
More overhead is allocated to each pair of chinos than to
each pair of jeans.
Altering the allocation base cannot change the total amount
of overhead incurred but will usually shift cost from some
products to the others.
Choice of allocation base should be done on industry basis.
If significant components of overhead increases as direct
labor hours increases as in this case then direct labor hour
should be the allocation base preferred over units of
07/ba422/Management Accounting
Thank you