Cost Allocation Methods in the Companies

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Table of Contents

Introduction
Hula Hug Corporation
Gutierrez Company

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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