# Justify costs or obtain reimbursement eg govt

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Justify costs or obtain reimbursement. Eg: Govt Contracts
Purposes of Cost Allocation 1. Predict economic effects of strategic and operational control decisions To take major strategic decisions: Optimal product, establishing pricing policy, policy to develop value-chain functions To predict the economic effects benefits and costs Eg: Addition of new course in a university Addition of new flights Addition of new specialty in a medical clinic
Purposes of Cost Allocation 2. Provide desired motivation and feedback for performance evaluation. Managers responsible for total costs that include allocated costs To make sure the benefits of the services exceed the costs
Purposes of Cost Allocation 3. Compute income and asset valuations for financial reporting. Costs are allocated to products to measure inventory costs for their balance sheets cost of goods for their income statements
Purposes of Cost Allocation 4. Justify costs or obtain reimbursement. Organisations base prices directly on costs. Eg: Govt contracts often specify a price that includes reimbursement for cost plus some profit margin Cost allocations directly determine the revenue received from a product / service
Methods of cost allocation Direct costs are physically traced to a cost object. Indirect costs are allocated using a cost-allocation base and it is more complex.
Methods of cost allocation Five Step Process 1 Accumulate indirect costs for a period of time into one or more cost pools. 2 Select an allocation base for each cost pool, preferably a cost driver 3 Measure the units of the cost-allocation base for each cost object (e.g., a product) and compute the total units for all cost objects (e.g., all products). 4 Determine the percentage of total cost-allocation base units used for each cost object. 5 . Multiply the percentage in step 4 by the total costs in the cost pool to determine the cost allocated to each cost object.
Methods of cost allocation Five Step Process 1 The cost of depreciation for the month of July is \$400000 2 The cost allocation base : Machine hours 3 2000 machine hours used for making Ultrabook and 3000 machine hours used for making Latitude laptop, total machine hours 5000 4 2000/5000 = 40% for Ultrabook, 3000/5000 = 60% for Latitude 5 Depreciation cost of Ultrabook: 40% of \$400000 = 160000 and Depreciation cost of Latitude : 60% of \$400000 = 240000 Depreciation on Dell’s assembly equipment Allocation of \$400000 depreciation to Ultrabook and Latitude laptop computers
Unallocated Costs Some costs lack an identifiable relationship to a cost object. Often it is best to leave such costs unallocated. Unallocated costs are costs that an accounting system records but does not allocate to any cost object Eg: R&D, Process Design, legal expenses, accounting, information services
Unallocated Costs Li Company’s Statement of Operating Income Li Company makes cabinets, tables and chairs Li Company used 9000, 6000, and 7000 machine hours to make cabinets, tables and chairs respectively a total of 22 thousands machine hours Product Distribution : Shipments of cabinets, tables and chairs weighed 6000, 4000 and 5000 pounds respectively for a total of 15000 pounds

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