1. Allocation of Indirect Costs
Slicing and Dicing for a purpose!

2. Comparing how costs behave
Direct costs
Indirect costs
Easily traceable to a cost object
In manufacturing, direct labor and direct materials are easily traced to one unit of product
In a department of a store, department manager salary, cost of goods sold, easily traced to each department
Cannot be easily traceable to a cost object
In manufacturing, indirect labor, indirect materials, factory costs (utilities, rent, depreciation, property tax, insurance) to one unit of product
In a department store, store manager salary (indirect to a single department)

3. Cost Object is an important starting point!
Why are we doing a cost allocation?
What is the “object” that we are costing?
Examples of a cost object – cost of one unit manufactured, cost of running a department this year, cost of the store for one day, etc.
Allocate indirect costs to your cost object – direct costs can be easily traced and do not need allocations

4. Common Cost terms Cost Driver Cost pool May need several allocations
Should have a strong cause and effect relationship to the indirect cost being allocated
Manufacturing Examples – direct labor hours, direct labor costs, square footage, machine hours, units produced, etc.
Example – cost of indirect labor pool allocated with direct labor costs as the cost driver
Service company examples – square footage, revenue, # of employees
May need several allocations
Group similar indirect costs together that are related
Cost pools could include such things as utilities (gas, water, electricity)
Assign one appropriate cost driver to that particular cost pool
Too many pools may be costly to maintain

5. Calculating the Allocation rate
Estimated indirect costs divided by estimated total cost driver
Examples would include calculating cost per direct labor hour (indirect labor cost/total direct labor hours or dollars), cost per square footage (cost of building maintenance/total square footage), etc.
For manufacturing, the predetermined overhead rate is an example of an allocation.

6. Determining the total indirect costs allocated to the cost object
Allocation rate times the actual amount of the cost driver
Examples
Cost object – determine the cost of running department A for a year
Utility cost per square feet times the actual square feet in department A
Company manager’s salary per employee times the number of employees in department A
IT support costs per computer times the number of computers in department A