Chapter 11, Problem 1RQ

Why do companies allocate costs? What are some of the advantages and disadvantages to doing so?

To determine

Explain why companies allocate costs and some of the advantages and disadvantages of allocation.

Explanation of Solution

Cost allocation:

Cost allocation refers to the process where the common cost of the production and service rendered to the various departments of the business are distributed. It is used to calculate the actual cost attributed to a specific department.

The main purpose of cost allocation is providing detailed cost information to the management. It is essential because it is the process through which cost incurred in producing a product or service is determined. If costs are wrongly allocated a business would be wasting resources on products that are improperly determined as profitable.

It is used to calculate the actual cost attributed to a specific department.

Some of the advantages of cost allocation include:

• It helps in cost control.
• It prevents frauds and manipulation.
• It provides help in the formulation of policies.

Some of the disadvantages of cost allocation include:

• The installation of a costing system is quite expensive, and only big firms can afford it.
• It is said that maintenance of cost records is unnecessary and involves duplication of work.
• The modern methods of cost allocation do not apply to many types of industries.