Question

What is the point of allocating costs? After allocation, how is the resulting information used?

Answer 1

a. Meaning: Cost allocation refers to assigning of various costs to its cost objects by summarising and identifying it.We need to allocate cost in order to know the areas where the company is incurring most costs by product, department or other method.

Explanation with example: If a company is involved in a manfucturing business, it is dealing in large variety of products may be, Buscuit, Dairy products, Cosmetics, etc. So, if we are not allocating costs to its respective product divisions then it will be difficult to determine which division is providing us profits or which division is incurring losses. Those costs are incurred irrespective of the quantity of products are fixed costs and those which vary with the change in quantity are variable. Certain costs which are related to a company's products or services are allocated to the respective product or services. Those which are related to a respective department of a company are allocated to that department.

b. Use of the resulting information of Cost Allocation:

The information provided after allocating costs are used for following purposes:

i. Decision making- In order to make decision whether to continue making a product or not,

ii. For cost reduction purpose- To determine the areas like- prime cost, factory cost or selling and distribution in order to perform cost reduction,

iii. In order to reduce waste ,

iv. In order to earn profit.