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Cost Allocation Methods in the Companies Essay

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Updated: May 11th, 2022

Introduction

Production overheads are costs incurred in an organization that cannot be directly attributed to any products. Therefore, the costs should be shared across the products. The overheads need to be shared fairly to ensure that the gains from the sale of the product are not understated. There are three main steps of sharing the production overheads. These processes are the allocation of costs, apportionment, and absorption of costs. This paper discusses various methods of allocating costs (traditional method and activity-based costing) using two companies.

Hula Hug Corporation

Part one – allocation of cost using the traditional method

Total overhead 131,200
Roundabout 67,200
Sassafras 64,000

Part two – activity proportions

Activity-based costing assigns actual consumption to each cost center. Activity proportions are used for each unit. The activity proportions are summarized in the table below.

Material handling 19,650
Number of moves 1000
Cost per move 19.65
Quality control 78,750
Number of inspections 10,500
Cost per inspection 7.5
Maintenance 32,800
Number of machine hours 41,000
Cost per machine hour 0.80

From the table, the activity proportions for material handling is $19.65, quality control is $7.5, and maintenance is $0.80.

Part three – allocation of overhead

The table below summarizes the costs allocated to each cost center.

Roundabout model
Material handling 11,298.75
Quality control 45,000
Maintenance 16,800
Total overhead 73,098.75

The total overhead for the roundabout model amounts to $73,098.75.

Part four – allocation of cost

Sassafras model
Material handling 8,351.25
Quality control 33,750
Maintenance 16,000
Total overhead 58,101.25

The total overhead for the Sassafras model amounts to $58,101.25.

Part Five – comparison of costs

Traditional ABC costing
Roundabout model 67,200 73,098.75
Sassafras model 64,000 58,101.25

From the table, ABC costing assigns more costs to the Roundabout model than the traditional costing. The ABC method is more accurate than the traditional method of allocating costs.

Gutierrez Company

Part one – traditional costing method

Machine hours Percentage Overhead assigned
Sportsman model 1,400 50% 5,590
Expedition model 1,400 50% 5,590
11,180

Based on the traditional method of cost accounting both sportsman and expedition models will have an equal amount of cost amounting to $5,590

Part two – Production cost per unit

The table below summarizes the production cost per unit under the traditional costing system.

Allocated cost Number of units Overhead assigned
Sportsman model 5,590 1,200 4.658
Expedition model 5,590 960 5.82

The overhead per unit of sportsman model amounts to $4.658 while for expedition amounts to $5.82. This implies that the production of more units reduces the cost per unit. The table below summarizes the total cost per unit of the models.

Sportsman model Expedition model
Direct material 20 28
Direct labor 15 19
Overhead 4.66 5.82
Unit cost 39.66 52.82

Part three – gross margin

Sportsman model Expedition model
Price per unit 82 105
Unit cost 39.66 52.82
Gross margin $42.34 $52.18

Part four – activity proportions

Setup costs 65
Quality control 12.50
Maintenance 1.10

Part Five – overhead assigned

Sportsman Expedition
Setup cost 910 1690
Quality control 1,750 3,750
Maintenance 1,540 1,540
Total 4,200 6,980
Overhead per unit 3.5 7.27

Part six – Production cost per unit

Sportsman model Expedition model
Direct material 20 28
Direct labor 15 19
Overhead 3.5 7.27
Unit cost 38.50 54.27

Part seven – gross margin

Sportsman model Expedition model
Price per unit 82 105
Unit cost 38.5 54.27
Gross margin $43.5 $50.73

Part eight – comparison of gross profit margin

Sportsman model Expedition model
Gross margin (traditional) $42.34 $52.18
Gross margin (ABC) $43.5 $50.73

The traditional approach yields higher profit for the expedition model while under ABC the profitability of the model reduces. The gross margin for sportsmen under the traditional method was lower than that under the ABC method.

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