Chapter 5

Cost systems for cost allocations

Cost centres and responsibility centres
The two-stage allocation process.
Cost centres classification.
The overhead rate and pre-determined overhead rates
 How to assign and manage indirect costs?
Responsibility
centers
Indirect labor costs Responsibility
(doorman, receptionist, center 1
hotel manager, maintenance
engineer, gardener,
Responsibility
plumber, housekeeping,
laundry staff, waiter, center 2
cooks,…)
Responsibility
Utilities (water, electricity,
gas), insurance, center 3
depreciation (building,
heating and air conditioning Responsibility
equipment, furniture, center 4
computers…) cleaning
supplies, linen and cloths… Responsibility
Allocation bases? center 5

Chapter 5 Mª Jesús Bonilla

 Allocation and apportioning of indirect costs
Responsibility center: A unit, part, segment of a firm where an
individual manager is held responsible for the units’ performance.

 These responsibility centers can be created based on functions, but

don’t have to.
 Each unit is concerned with a particular aspect of the organization,
that is a set of activities.
 Depending on which terms the performance of the unit is defined,
the performance of the manager will be assessed.

Chapter 5 Mª Jesús Bonilla

 Allocation and apportioning of indirect costs
Responsibility centers are linked to responsibility accounting.

A part of an organization that a

A set of accounting measures
manager is accountable for.
used to evaluate the center and
therefore the manager’s
performance.

work unit (ex.: maintenance parts/20)

The work unit or indirect cost allocation rate is a unit of measure of the activity of a plant that
allows both the control of the activity and the allocation of costs from the plants to the various
cost objects.
Chapter 5 Mª Jesús Bonilla
 Responsibility center or activity center

Cost center Profit center

Chapter 5 Mª Jesús Bonilla

 Allocation and apportioning of indirect costs
Profit centers:

Responsibility centers whose managers are accountable for its profit.

The center and the manager’s performance will be measured in terms of
profit.
The manager will be responsible of revenues and costs.
In accounting terms it will be a location where costs and sales are
grouped.
They are commonly used in hospitality industry.
Eg: Hotel manager oversees a profit center as is the Restaurant center (also is a cost
center)

Chapter 5 Mª Jesús Bonilla

 Allocation and apportioning of indirect costs
Cost centers:
o Cost centers are responsibility centers whose managers are
normally accountable for costs, because the activity of these centres
mainly generate costs.
o The manager can influence decisions which only affect costs.
o In accounting terms, they are used to describe a location where
costs are grouped.
o Eg: housekeeping centre, laundry centre, maintenance…

Chapter 5 Mª Jesús Bonilla

 Allocation and apportioning of indirect costs

Cost center Profit center

department charged with direct and department which recognizes the

indirect costs benefit.

determines the exact profit and seeks

controls the cost and seeks to reduce the
actual cost from the standard cost
is a department of an organization for
which costs are determined,
to increase the actual profit with
respect to the budgeted one How?
By reducing the actual cost from the
budgeted cost
is a department of an organization
that determines the profitability of an
organization.

Chapter 5
there are many cost centers on a single profit center Mª Jesús Bonilla
 Example: Laundry as a center

Some centers can be defined in different terms depending on

how they operate. Laundry center can be defined as:

Cost center: When it is providing an internal service to do laundry for

own hotel and restaurant linen.

Revenue center: When it is providing an outsourced service to

clients and the hotel charges a comisión to guests.

Profit center: When it is an own internal service provided by the hotel

which attends clients.

Chapter 5 Mª Jesús Bonilla

 Manufacturing Costs (Chapter 3)

Direct Direct Manufacturing

Chapter 4 Chapter 5 Overhead
Materials Labor

Chapter 5 The Product / service Mª Jesús Bonilla

 Assignment of indirect costs
Cost classification for assigning costs:
 Direct costs
 Indirect costs: cannot be easily and conveniently traced to a
unit of product or other cost object.
Other costs related to
the cost object which
Indirect are not material costs or
Indirect
Labor labor costs: heating
Materials
costs, insurance,
depreciation

Overhead costs
Chapter 5 Mª Jesús Bonilla
 Assignment of indirect costs

Chapter 5 Mª Jesús Bonilla

 Assignment of indirect costs
Why to assign indirect costs?
management accounting are. Chapter 1)
For manufacturing
companies
 To meet accounting
requirements as inventories
should be valued at
manufacturing costs.
 To provide useful information
for management decisions in
relation to manufacturing and
non-manufacturing costs.
 To reduce frivolous use of
common costs.
Chapter 5
(What the functions of cost and
For servicing companies
 Costs systems are not
required for meeting
inventory valuation
requirements.
 To provide useful
information for decision
making
 To reduce frivolous use of
common costs.
Mª Jesús Bonilla
 Assignment of indirect costs
Therefore… management accountants
has to devise a scheme of allocation.

Is the process of
assigning costs when
Cost allocation a direct measure does
not exist.

This involves the use of surrogate measures: ALLOCATION BASES

(cost driver)

Chapter 5 Mª Jesús Bonilla

 Assignment of indirect costs
ALLOCATION BASES:
 They must be significant determinants of
the costs.

 They must show the cause-effect

relationship.

If not, they are called arbitrary allocations, and lead to

innacurate cost assignment.

Chapter 5 Mª Jesús Bonilla

 Process

Direct Indirect

ALLOCATED
TRACED
costs costs

Chapter 5 Mª Jesús Bonilla

 Assignment of indirect costs

1 2

3
Chapter 5 Mª Jesús Bonilla
 INDIRECT COST allocation process
Responsibility
Allocation
centers (Service
base Reallocate
cost centers and
Labor costs Product cost Products/SS sold
(doorman, centers) C
receptionist, hotel O
manager,
Responsibility Rooms
maintenance
occupied/ S
engineer, gardener, center 1
plumber, (Product cc) Rooms service T
housekeeping, Responsibility
laundry staff, waiter, center 2 Breakfast
cooks,…) (Producto cc) O
Utilities (water, Responsibility
electricity, gas), center 3 (Service Maintenance B
insurance, cc) parts J
depreciation Events and meetings:
Responsibility center a wedding, business E
(building, heating
and air conditioning
4 (Product cc) presentation, a C
equipment, furniture, conference
computers…) Restaurant services: T
cleaning supplies, Responsibility lunch, dinner sold,
linen and cloths… center 5 (Product cc) cocktails
Chapter 5 Mª Jesús Bonilla