Lecture 2: Different Methods of Allocating Costs
In the case of a firm where all the production units are similar, calculating the full cost of one
individual item is easy as the indirect costs can be equally distributed among the production units
(Process Costing). However in the case of a firm where the production units are different the
challenge is allocating the fair share of the indirect costs to each product (Job Costing).
Different Methods of allocating costs are:
1. Plant wide overhead rate:
Calculate the total overheads
Select a cost driver
Calculate the overheads per unit of cost driver
Calculate the overheads cost for individual product based on the units of cost drivers
it consumes.
2. Departmental basis:
When costs are allocated on a departmental basis, each department is called a cost
centre.
Two types of cost centres:
Product cost centres are departments in which jobs are worked on by direct workers
and/or where direct materials are added. Example: manufacturing department
Service cost centres are the ones where no direct costs are involved. These
departments render a service to other cost centres. Examples: General
administration, accounting, maintenance, personnel, catering.
To identify the full cost of a product, overheads from service cost centres need to
first be charged to product cost centres, so that they can subsequently be re-
charged to particular jobs.
Steps in calculating the full cost on departmental basis:
STEP 1: Allocate Specific departmental Overheads to the relevant department
STEP 2: APPORTION general overheads between departments
STEP 3: SUM UP allocated and apportioned overheads (OHs) for each dept.
STEP 4: APPORTION service department costs to product cost centers
STEP 5: Sum up PRODUCT cost center Overheads
In the case of a firm where all the production units are similar, calculating the full cost of one
individual item is easy as the indirect costs can be equally distributed among the production units
(Process Costing). However in the case of a firm where the production units are different the
challenge is allocating the fair share of the indirect costs to each product (Job Costing).
Different Methods of allocating costs are:
1. Plant wide overhead rate:
Calculate the total overheads
Select a cost driver
Calculate the overheads per unit of cost driver
Calculate the overheads cost for individual product based on the units of cost drivers
it consumes.
2. Departmental basis:
When costs are allocated on a departmental basis, each department is called a cost
centre.
Two types of cost centres:
Product cost centres are departments in which jobs are worked on by direct workers
and/or where direct materials are added. Example: manufacturing department
Service cost centres are the ones where no direct costs are involved. These
departments render a service to other cost centres. Examples: General
administration, accounting, maintenance, personnel, catering.
To identify the full cost of a product, overheads from service cost centres need to
first be charged to product cost centres, so that they can subsequently be re-
charged to particular jobs.
Steps in calculating the full cost on departmental basis:
STEP 1: Allocate Specific departmental Overheads to the relevant department
STEP 2: APPORTION general overheads between departments
STEP 3: SUM UP allocated and apportioned overheads (OHs) for each dept.
STEP 4: APPORTION service department costs to product cost centers
STEP 5: Sum up PRODUCT cost center Overheads
