Quiz 4: Cost Allocation


Traditional costing refers to distribution of factory costs over the products on the basis of quantum of production resources consumed. By using this method, the overhead is generally deployed on the basis of either the amount of direct labour time deployed or machine hours consumed. Benefits of using traditional-based costing is that it macthes the methods of costing with GAAP. It would also be easy for a company that is specialized in one product to implement such traditional costing method. In given case, it has been required to provide the factors leading to inaccurate product costing based on traditional costing method. Following are the factors of traditional costing method leading to inaccurate costing product: 1. Traditional costing is an outdated costing system because such manufacturing corporates use machinery and computers for total produced output. Such corporations are now in use of new methodological techniques of production and have considered traditional method as obsolete. 2. Computers and machinery would let the traditional system to be outdated as latter system used to consider the direct labour hours to compute the cost. Cost is not appropriately distributed as direct labour hours are not the appropriate measure to be used. In many corporations, large servers and machines are operated to run the production and traditional method is not capable to account for cost associated with such machines. 3. Traditional system has made other system to get affected by it as former system has eliminated additional cost parameters that may put in to cost attribute of the product. 4. Besides above factors, there is one important aspect of traditional system that it excludes certain non-manufacturing costs which leads to bad management of the corporation.

Allocation base is the criteria based on which the costs are allocated to various cost-centers or revenue centers as given for an entity. There are various bases of cost allocation like service hours for a house keeping department, number of employees for an administration department etc. Sometimes costs are allocated on compound bases like number of patient days etc. For example, in case of allocation of cost of house-keeping department, one will choose service hours as allocation base. If the total cost of the department is Rs. 10,000 for the month and a total of 100 service hours are projected, then the rate shall be calculated as follows: img Thus, the allocation rate has been computed above as $100 per service hour.

Overhead refers to the costs that are usually indirect in nature and cannot be directly attributed to the services/products provided by the organization. They are the indirect cost and cannot be directly assigned to the output. In case of hospital, Housekeeping service costs would be an overhead which cannot be directly attributed to the services provided to a single patient. In order to assign these costs, an overhead allocation rate is calculated. Usually, health care organizations allocate such costs on the number of hours of service consumed by the department. Hence, if the nursing department has consumed more number of hours for housekeeping, it would not affect the overhead charges allocated to laboratory department if, number of hours of service is used as an allocation base. However, if the allocation base used to charge the cost of house-keeping services is "square feet", then the allocation would be different and laboratory department will be charged based on the square-feet it is spread-through irrespective of the number of service-hours utilized.