what is cost assignment

What is Cost Assignment?

Cost Assignment

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Cost assignment.

Cost assignment is the process of associating costs with cost objects, such as products, services, departments, or projects. It encompasses the identification, measurement, and allocation of both direct and indirect costs to ensure a comprehensive understanding of the resources consumed by various cost objects within an organization. Cost assignment is a crucial aspect of cost accounting and management accounting, as it helps organizations make informed decisions about pricing, resource allocation, budgeting, and performance evaluation.

There are two main components of cost assignment:

  • Direct cost assignment: Direct costs are those costs that can be specifically traced or identified with a particular cost object. Examples of direct costs include direct materials, such as raw materials used in manufacturing a product, and direct labor, such as the wages paid to workers directly involved in producing a product or providing a service. Direct cost assignment involves linking these costs directly to the relevant cost objects, typically through invoices, timesheets, or other documentation.
  • Indirect cost assignment (Cost allocation): Indirect costs, also known as overhead or shared costs, are those costs that cannot be directly traced to a specific cost object or are not economically feasible to trace directly. Examples of indirect costs include rent, utilities, depreciation, insurance, and administrative expenses. Since indirect costs cannot be assigned directly to cost objects, organizations use various cost allocation methods to distribute these costs in a systematic and rational manner. Some common cost allocation methods include direct allocation, step-down allocation, reciprocal allocation, and activity-based costing (ABC).

In summary, cost assignment is the process of associating both direct and indirect costs with cost objects, such as products, services, departments, or projects. It plays a critical role in cost accounting and management accounting by providing organizations with the necessary information to make informed decisions about pricing, resource allocation, budgeting, and performance evaluation.

Example of Cost Assignment

Let’s consider an example of cost assignment at a bakery called “BreadHeaven” that produces two types of bread: white bread and whole wheat bread.

BreadHeaven incurs various direct and indirect costs to produce the bread. Here’s how the company would assign these costs to the two types of bread:

  • Direct cost assignment:

Direct costs can be specifically traced to each type of bread. In this case, the direct costs include:

  • Direct materials: BreadHeaven purchases flour, yeast, salt, and other ingredients required to make the bread. The cost of these ingredients can be directly traced to each type of bread.
  • Direct labor: BreadHeaven employs bakers who are directly involved in making the bread. The wages paid to these bakers can be directly traced to each type of bread based on the time spent working on each bread type.

For example, if BreadHeaven spent $2,000 on direct materials and $1,500 on direct labor for white bread, and $3,000 on direct materials and $2,500 on direct labor for whole wheat bread, these costs would be directly assigned to each bread type.

  • Indirect cost assignment (Cost allocation):

Indirect costs, such as rent, utilities, equipment maintenance, and administrative expenses, cannot be directly traced to each type of bread. BreadHeaven uses a cost allocation method to assign these costs to the two types of bread.

Suppose the total indirect costs for the month are $6,000. BreadHeaven decides to use the number of loaves produced as the allocation base , as it believes that indirect costs are driven by the production volume. During the month, the bakery produces 3,000 loaves of white bread and 2,000 loaves of whole wheat bread, totaling 5,000 loaves.

The allocation rate per loaf is:

Allocation Rate = Total Indirect Costs / Total Loaves Allocation Rate = $6,000 / 5,000 loaves = $1.20 per loaf

BreadHeaven allocates the indirect costs to each type of bread using the allocation rate and the number of loaves produced:

  • White bread: 3,000 loaves × $1.20 per loaf = $3,600
  • Whole wheat bread: 2,000 loaves × $1.20 per loaf = $2,400

After completing the cost assignment, BreadHeaven can determine the total costs for each type of bread:

  • White bread: $2,000 (direct materials) + $1,500 (direct labor) + $3,600 (indirect costs) = $7,100
  • Whole wheat bread: $3,000 (direct materials) + $2,500 (direct labor) + $2,400 (indirect costs) = $7,900

By assigning both direct and indirect costs to each type of bread, BreadHeaven gains a better understanding of the full cost of producing each bread type, which can inform pricing decisions, resource allocation, and performance evaluation.

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  • Cost Classifications
  • Relevant Cost of Material
  • Manufacturing Overhead Costs
  • Conversion Costs
  • Quality Costs
  • Revenue Expenditure
  • Product Cost vs Period Cost
  • Direct Costs and Indirect Costs
  • Prime Costs and Conversion Costs
  • Relevant vs Irrelevant Costs
  • Avoidable and Unavoidable Costs
  • Cost Allocation
  • Joint Products
  • Accounting for Joint Costs
  • Service Department Cost Allocation
  • Repeated Distribution Method
  • Simultaneous Equation Method
  • Specific Order of Closing Method
  • Direct Allocation Method

Cost allocation is the process by which the indirect costs are distributed among different cost objects such as a project, a department, a branch, a customer, etc. It involves identifying the cost object, identifying and accumulating the costs that are incurred and assigning them to the cost object on some reasonable basis.

Cost allocation is important for both pricing and planning and control decisions. If costs are not accurately calculated, a business might never know which products are making money and which ones are losing money. If cost are mis-allocated, a business may be charging wrong price to its customers and/or it might be wasting resources on products that are wrongly categorized as profitable.

Cost allocation is a sub-process of cost assignment , which is the overall process of finding total cost of a cost object. Cost assignment involves both cost tracing and cost allocation. Cost tracing encompasses finding direct costs of a cost object while the cost allocation is concerned with indirect cost charge.

Steps in cost allocation process

Typical cost allocation mechanism involves:

  • Identifying the object to which the costs have to be assigned,
  • Accumulating the costs in different pools,
  • Identifying the most appropriate basis/method for allocating the cost.

Cost object

A cost object is an item for which a business need to separately estimate cost.

Examples of cost object include a branch, a product line, a service line, a customer, a department, a brand, a project, etc.

A cost pool is the account head in which costs are accumulated for further assignment to cost objects.

Examples of cost pools include factory rent, insurance, machine maintenance cost, factory fuel, etc. Selection of cost pool depends on the cost allocation base used. For example if a company uses just one allocation base say direct labor hours, it might use a broad cost pool such as fixed manufacturing overheads. However, if it uses more specific cost allocation bases, for example labor hours, machine hours, etc. it might define narrower cost pools.

Cost driver

A cost driver is any variable that ‘drives’ some cost. If increase or decrease in a variable causes an increase or decrease is a cost that variable is a cost driver for that cost.

Examples of cost driver include:

  • Number of payments processed can be a good cost driver for salaries of Accounts Payable section of accounting department,
  • Number of purchase orders can be a good cost driver for cost of purchasing department,
  • Number of invoices sent can be a good cost driver for cost of billing department,
  • Number of units shipped can be a good cost driver for cost of distribution department, etc.

While direct costs are easily traced to cost objects, indirect costs are allocated using some systematic approach.

Cost allocation base

Cost allocation base is the variable that is used for allocating/assigning costs in different cost pools to different cost objects. A good cost allocation base is something which is an appropriate cost driver for a particular cost pool.

T2F is a university café owned an operated by a student. While it has plans for expansion it currently offers two products: (a) tea & coffee and (b) shakes. It employs 2 people: Mr. A, who looks after tea & coffee and Mr. B who prepares and serves shakes & desserts.

Its costs for the first quarter are as follows:

Total tea and coffee sales and shakes sales were $50,000 & $60,000 respectively. Number of customers who ordered tea or coffee were 10,000 while those ordering shakes were 8,000.

The owner is interested in finding out which product performed better.

Salaries of Mr. A & B and direct materials consumed are direct costs which do not need any allocation. They are traced directly to the products. The rest of the costs are indirect costs and need some basis for allocation.

Cost objects in this situation are the products: hot beverages (i.e. tea & coffee) & shakes. Cost pools include rent, electricity, music, internet and wi-fi subscription and magazines.

Appropriate cost drivers for the indirect costs are as follows:

Since number of customers is a good cost driver for almost all the costs, the costs can be accumulated together to form one cost pool called manufacturing overheads. This would simply the cost allocation.

Total manufacturing overheads for the first quarter are $19,700. Total number of customers who ordered either product are 18,000. This gives us a cost allocation base of $1.1 per customer ($19,700/18,000).

A detailed cost assignment is as follows:

Manufacturing overheads allocated to Tea & Cofee = $1.1×10,000

Manufacturing overheads allocated to Shakes = $1.1×8,000

by Irfanullah Jan, ACCA and last modified on Jul 22, 2020

Related Topics

  • Cost Behavior

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Module 5: Job Order Costing

Introduction to accumulating and assigning costs, what you will learn to do: assign costs to jobs.

Financial and managerial accountants record costs of production in an account called Work in Process. The total of these direct materials, direct labor, and factory overhead costs equal the cost of producing the item.

In order to understand the accounting process, here is a quick review of how financial accountants record transactions:

Let’s take as simple an example as possible. Jackie Ma has decided to make high-end custom skateboards. She starts her business on July 1 by filing the proper forms with the state and then opening a checking account in the name of her new business, MaBoards. She transfers $150,000 from her retirement account into the business account and records it in a journal as follows:

For purposes of this ongoing example, we’ll ignore pennies and dollar signs, and we’ll also ignore selling, general, and administrative costs.

After Jackie writes the journal entry, she posts it to a ledger that currently has only two accounts: Checking Account, and Owner’s Capital.

A journal entry dated July 01 shows a debit of $150,000 to Checking Account and a credit of $150,000 to Owner’s Capital with the note “Owner’s investment - initial deposit to business bank account”. Each line item in the journal entry points to the corresponding debit or credit on its respective t-account.

Debits are entries on the left side of the account, and credits are entries on the right side.

Here is a quick review of debits and credits:

You can view the transcript for “Colin Dodds – Debit Credit Theory (Accounting Rap Song)” here (opens in new window) .

Also, this system of debits and credits is based on the following accounting equation:

Assets = Liabilities + Equity.

  • Assets are resources that the company owns
  • Liabilities are debts
  • Equity is the amount of assets left over after all debts are paid

Let’s look at one more initial transaction before we dive into recording and accumulating direct costs such as materials and labor.

Jackie finds the perfect building for her new business; an old woodworking shop that has most of the equipment she will need. She writes a check from her new business account in the amount of $2,500 for July rent. Because she took managerial accounting in college, she determines this to be an indirect product expense, so she records it as Factory Overhead following a three-step process:

  • Analyze transaction

Because her entire facility is devoted to production, she determines that the rent expense is factory overhead.

2. Journalize transaction using debits and credits

If she is using QuickBooks ® or other accounting software, when she enters the transaction into the system, the software will create the journal entry. In any case, whether she does it by hand or computer, the entry will look much like this:

3. Post to the ledger

Again, her computer software will post the journal entry to the ledger, but we will follow this example using a visual system accountants call T-accounts. The T-account is an abbreviated ledger. Click here to view a more detailed example of a ledger .

Jackie posts her journal entry to the ledger (T-accounts here).

A journal entry dated July 03 shows a debit of $2,500 to Factory Overhead and a credit of $2,500 to Checking Account with the note “Rent on manufacturing facility”. Each line item in the journal entry points to the corresponding debit or credit on its respective t-account.

She now has three accounts: Checking Account, Owner’s Capital, and Factory Overhead, and the company ledger looks like this:

A t-account for Checking Account shows a debit of $150,000 beginning balance, a credit of $2,500 dated July 03, and $147,500 ending debit balance. A t-account for Owner's Capital shows a credit of $150,000 beginning and ending balance. A t-account for Factory Overhead shows a debit of $2,500 dated July 03 beginning balance and a debit of $2,500 ending balance.

In a retail business, rent, salaries, insurance, and other operating costs are categorized into accounts classified as expenses. In a manufacturing business, some costs are classified as product costs while others are classified as period costs (selling, general, and administrative).

We’ll treat factory overhead as an expense for now, which is ultimately a sub-category of Owner’s Equity, so our accounting equation now looks like this:

Assets = Liabilities + Owner’s Equity

147,500 = 150,000 – 2,500

Notice that debits offset credits and vice versa. The balance in the checking account is the original deposit of $150,000, less the check written for $2,500. Once the check clears, if Jackie checks her account online, she’ll see that her ledger balance and the balance the bank reports will be the same.

Here is a summary of the rules of debits and credits:

Assets = increased by a debit, decreased by a credit

Liabilities = increased by a credit, decreased by a debit

Owner’s Equity = increased by a credit, decreased by a debit

Revenues increase owner’s equity, therefore an individual revenue account is increased by a credit, decreased by a debit

Expenses decrease owner’s equity, therefore an individual expense account is increased by a debit, decreased by a credit

Here’s Colin Dodds’s Accounting Rap Song again to help you remember the rules of debits and credits:

Let’s continue to explore job costing now by using this accounting system to assign and accumulate direct and indirect costs for each project.

When you are done with this section, you will be able to:

  • Record direct materials and direct labor for a job
  • Record allocated manufacturing overhead
  • Prepare a job cost record

Learning Activities

The learning activities for this section include the following:

  • Reading: Direct Costs
  • Self Check: Direct Costs
  • Reading: Allocated Overhead
  • Self Check: Allocated Overhead
  • Reading: Subsidiary Ledgers and Records
  • Self Check: Subsidiary Ledgers and Records
  • Introduction to Accumulating and Assigning Costs. Authored by : Joseph Cooke. Provided by : Lumen Learning. License : CC BY: Attribution
  • Colin Dodds - Debit Credit Theory (Accounting Rap Song). Authored by : Mr. Colin Dodds. Located at : https://youtu.be/j71Kmxv7smk . License : All Rights Reserved . License Terms : Standard YouTube License
  • What the General Ledger Can Tell You About Your Business. Authored by : Mary Girsch-Bock. Located at : https://www.fool.com/the-blueprint/general-ledger/ . License : All Rights Reserved . License Terms : Standard YouTube License

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COST ASSIGNMENT Definition

COST ASSIGNMENT involves assigning costs of an account to the accounts that are responsible or accountable for incurring the cost. For example, the cost of issuing purchase orders is allocated to the various objects procured. The cost assignment is done through assignment paths and cost drivers. The assignment path identifies the source account (the account whose cost is being assigned "Issue Purchase Orders" in the above example) and destination accounts (the accounts to which the costs are being allocated the various cost objects procured by issuing purchase orders in the above example). The cost driver identifies the measure or rationale on the basis of which the assignment needs to be done, that is, whether the costs of issuing purchase orders need to be assigned to various cost objects evenly, based on some defined percentage values, or based on some criterion, like the number of purchase orders of each cost object issued. Defining the cost drivers and assignment paths (i.e., source and destination accounts) enable proper assignment and accounting of the various costs incurred in the organization.

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INVESTORS' COMPENSATION SCHEME is a statutory scheme operated by the UK Securities and Investment Board to give individual investors up to £48,000 protection if an authorized investment business collapses.

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what is cost assignment

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2.6: Process Costing (FIFO Method)

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Another acceptable method for determining unit cost under process costing is the first-in, first-out (FIFO) cost method. Under the FIFO method, we assume any units that were not completed last period (beginning work in process) are finished before anything else is started. The following table shows the differences between the weighted average method and the FIFO cost method:

We will look at each item individually as we discuss the steps of process costing. Under either method, weighted average or FIFO, process costing consists of 5 steps:

Physical Flow of Units

  • Equivalent Units

Cost per Equivalent Unit

  • Assign Costs to Units Completed and Ending Work in Process Inventory

Reconcile Costs

The physical flow of units is as follows under the weighted average method:

This is altered just slightly under the FIFO method as we must separate the items in units completed into Units Completed from beginning work in process and Units started and completed this period since under FIFO, we must finish anything from beginning work in process before we start something new. Under the FIFO, we the physical flow of units would be documented as:

Just as in the weighted average method, the 2 Total Units figures must agree!

Equivalent Units of Production

Under the FIFO method, we will calculate equivalent units for 3 things: Units completed from beginning work in process, units started and completed this period and units remaining in ending work in process. This video will discuss the differences between the Weighted Average and FIFO methods for equivalent units (if you are comfortable with the weighted average method, skip to minute 4:06 to begin the discussion on the FIFO method).

Thumbnail for the embedded element "Cost Accounting: Equivalent Units using FIFO & Weighted Average"

A YouTube element has been excluded from this version of the text. You can view it online here: http://pb.libretexts.org/ma/?p=78

Equivalent units for the period will be calculated as follows under FIFO ( keep in mind, you may have different percent complete for materials, labor and overhead ):

  • Units from beginning work in process: you want to complete this units, so how much MORE effort will be needed to finish these units. You will calculate this as beginning work in process units x (100% – given % complete) to calculate the amount of additional work necessary to make the unit 100% complete.
  • Units started and completed this period: take the units x 100% complete since they were started and completed they have received all of their materials, labor and overhead and will not receive any more since they are finished.
  • Units in Ending work in process: just like with the weighted average method, we will take the ending work in process units x a given % complete.

To illustrate the computation of equivalent units under the FIFO method, assume the following facts (for simplicity we are using just one percent complete for materials, labor and overhead):

The physical flow of units would be (calculate units started and completed as units started 10,000 – units in ending work in process 5,000):

The equivalent production for the period would be:

Under the weighted average method, we use beginning work in process costs AND costs added this period. Under the FIFO method, we will only use the costs added this period. This video will explain the differences between the two approaches.

Thumbnail for the embedded element "Cost Per Equivalent Unit-- FIFO Method vs. Weighted-average Method"

The formula we will use for calculating cost per equivalent unit under the FIFO Method is:

Assign Costs

When we assign costs to units completed and transferred and units remaining in ending work in process under the FIFO method, we need the following items:

  • Costs from beginning work in process: these were the costs we started the period with or the unfinished items from the previous period ( no calculation required — just bring over the costs from beginning work in process ). Remember, under FIFO, these are finished first so their costs must be passed along to completed units.
  • Costs to complete beginning work in process: you will take the Equivalent units calculated for completing beginning work in process x the cost per equivalent unit. You will do this for materials, labor and overhead (or for conversion costs which is the both direct labor and overhead).
  • Costs of units started and completed: you will take the equivalent units calculated for units started and completed x the cost per equivalent unit for materials, labor and overhead (or conversion).
  • The sum of these 3 will be the cost of units completed and transferred which is also known as cost of goods manufactured. This amount is transferred to the next department or to finished goods and out of work in process for the units completed this period.
  • Cost of units remaining in ending work in process: you will take the ending work in process equivalent units x the cost per equivalent unit for materials, labor and overhead (or conversion) just as we did under the weighed average method. This amount rolls over to be the next period’s beginning work in process inventory.

This video will provide a demonstration of cost assignment under the FIFO method.

Thumbnail for the embedded element "Cost Per Equivalent Unit, FIFO Method, Part 2 (Applying Costs)"

Finally, something is the same under FIFO and Weighted Average.

We want to make sure that we have assigned all the costs from beginning work in process and costs incurred or added this period to units completed and transferred and ending work in process inventory.

First, we need to know our total costs for the period (or total costs to account for) by adding beginning work in process costs to the costs incurred or added this period. Then, we compare the total to the cost assignment in step 4 for units completed and transferred and ending work in process to get total units accounted for. Both totals should agree.

The cost reconciliation would be:

In the next page, we will do a demonstration problem of the FIFO method for process costing.

Contributors and Attributions

  • Equivalent Units. Authored by : Linda Williams. License : All Rights Reserved . License Terms : Standard YouTube License
  • Cost Per Equivalent Unit-- FIFO Method vs. Weighted-average Method . Authored by : Education Unlocked. Located at : https://youtu.be/P_Nwchc_pcs . License : All Rights Reserved . License Terms : Standard YouTube License
  • Cost Per Equivalent Unit, FIFO Method, Part 2 (Applying Costs) . Authored by : Education Unlocked. Located at : https://youtu.be/y1TLRSL9Yjo . License : All Rights Reserved . License Terms : Standard YouTube License

What Is Cost Allocation?

Table of contents.

what is cost assignment

For your business to make money, you must charge prices that not only cover your expenses, but also provide a profit. Cost allocation is the process of identifying and assigning costs to the cost objects in your business, such as products, a project, or even an entire department or individual company branch.

While a detailed cost allocation report may not be vital for extremely small businesses, such as a teen’s lawn service, more complex businesses require the process of cost allocation to ensure profitability and productivity.

In short, if you can assign a cost to any part of your business, it’s considered a cost object.

What is cost allocation?

Cost allocation is the method business owners use to calculate profitability for the purpose of financial reporting . To ensure the business’s finances are on track, costs are separated, or allocated, into different categories based on the area of the business they impact.

For instance, cost allocation for a small clothing boutique would include the costs of materials, shipping and marketing. Calculating these costs consistently would help the store owner ensure that profits from sales are higher than the costs of owning and running the store. If not, the owner could easily pinpoint where to raise prices or cut expenses .

For a larger company, this process would be applied to each department or individual location. Many companies use cost allocation to determine which areas receive bonuses annually.

Regardless of your business size, you’ll want to review and choose the best accounting software to help this process run as smoothly as possible.

Types of costs

In the boutique example above, the process of cost allocation is pretty simple. For larger businesses, however, many more costs are involved. These costs break down into seven categories.

  • Direct costs: These expenses are directly related to a product or service. In your business’s financial statements, these costs can be linked to items sold. For a small clothing store, this might include the cost of inventory.
  • Direct labor: This cost category includes expenses directly related to the employee production of items or services your business sells. Direct labor costs include payroll for employees involved in making the items your business sells.
  • Direct materials: As the name suggests, this category includes costs related to the resources used to manufacture a finished product. Direct materials include fabric to make clothing, or the glass used in building tables.
  • Indirect costs: These expenses are not directly related to a product or service, but necessary to create the product or service. Indirect costs include payroll for those who work in operations. It also lists costs for materials you use in such small quantities that their costs are easy to overlook.
  • Manufacturing overhead: This category includes warehouse costs, and any other expenses directly related to manufacturing the products sold. Manufacturing overhead costs include payroll for warehouse managers, as well as warehouse expenses such as rent and utilities.
  • Overhead costs: These include expenses that support the company as a whole but are not directly related to production. Some examples of overhead costs are marketing, operations and utilities for a storefront.
  • Product costs: Also called “manufacturing costs” or “total costs,” this category includes expenses for making or acquiring the product you sell. All manufacturing overhead costs are also listed in this category.

Example of cost allocation

To better explain the process of cost allocation and why it’s necessary for businesses, let’s look at an example.

Dave owns a business that manufactures eyeglasses. In January, Dave’s overhead costs totaled $5,000. In the same month, he produced 3,000 eyeglasses with $2 in direct labor per product. Direct materials for each pair of eyeglasses totaled $5.

Here’s what cost allocation would look like for Dave:

Overhead: $5,000 ÷ $3,000 = $1.66 per pair

Direct costs:

  • Direct materials: $5 per pair
  • Direct labor: $2 per pair
  • Overhead: $1.66 per pair
  • Total cost: $8.66 per pair

As you can see, without cost allocation, Dave would not have made a profit from his sales. Larger companies would apply this same process to each department and product to ensure sufficient sales goals. [Read related article: How to Set Achievable Business Goals ]

How to allocate costs

Cost objects vary by business type. The cost allocation process, however, consists of the same steps regardless of what your company produces.

1. Identify cost objects.

To begin allocating costs, you’ll need to list the cost objects of your business. Remember that anything within your business that generates an expense is a cost object. Review each product line, project and department to ensure you’ve gathered all cost objects.

2. Create a cost pool.

Next, gather a detailed list of all business costs. It’s a good idea to categorize the costs based on the reason for each amount. Categories should cover utilities, insurance , square footage and any other expenses your business incurs.

3. Allocate costs.

Now that you’ve listed cost objects and created a cost pool, you’re ready to allocate costs. As demonstrated in the example above, add up the costs of each cost object. At a glance, your report should justify all expenses related to your business. If costs don’t add up correctly, use the list to determine where you can make adjustments to get back on track.

What is cost allocation used for?

Cost allocation is used for many reasons, both externally and internally. Reports created by this process are great resources for making business decisions , monitoring productivity and justifying expenses.

External reports are usually calculated based on generally accepted accounting principles (GAAP) . Under GAAP, expenses can only be reported in financial statements during the time period the associated revenue is earned. For this reason, overhead costs are divided and allocated to individual inventory items. When the inventory is sold, the overhead is expensed as a portion of the cost of goods sold (COGS) .

Internal financial data, on the other hand, is usually reported using activity-based costing (ABC). This method assigns all products to the overhead expenses they caused. This process may not include all overhead costs related to operations and manufacturing.

Cost allocation reports show which cost objects incur the most expenses for your business and which products or departments are most profitable. These findings can be a great resource to pair with employee monitoring software when evaluating productivity. If you determine that a cost object is not as profitable as it should be, you should do further evaluations on productivity. If another cost object is found to exceed expectations, you can use the report to find staff members who deserve recognition for their contributions to the company.

Recognition is one of the best ways to keep employees motivated .

What is a cost driver?

A cost driver is a variable that can change the costs related to a business activity. The number of invoices issued, the number of employee hours worked, and the total of purchase orders are all examples of cost drivers in cost accounting .

While cost objects are related to the specific process or product incurring the costs, a cost driver sheds light on the reason for the incurred cost amounts. These items can take different forms – including fixed costs, such as the initial fees during the startup phase . Cost drivers give a bird’s-eye view of the entire company and how each department operates.

It’s common for only one cost driver to be used with very small businesses , since they are focused on using minimal reporting to estimate overhead costs.

Benefits of cost allocation

  • It simplifies decision-making. Cost allocation gives you a detailed overview of how your business expenses are used. From this perspective, you can determine which products and services are profitable, and which departments are most productive.
  • It assists in staff evaluation. You can also use cost allocation to assess the performance of different departments. If a department is not profitable, the staff productivity may need improvement. Cost allocation can also be an indicator of departments that exceed expectations and deserve recognition. Awards and recognition are a great way to motivate staff and, in turn, increase productivity. [Read related article: Best Business Productivity Apps ]

Even if you operate a very small business, it’s a great idea to learn the process of cost allocation, especially if you anticipate expansion in the future. Since the method can be complex, it’s ideal to use accounting software as an aid. Whether you choose to start allocating costs on your own with software or hire a professional accountant , it’s a process no business owner can afford to overlook.

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The procedures by which direct or indirect costs are charged to or made the responsibility of particular cost centres, and ultimately charged to the products manufactured or services provided by the organization. Procedures used to achieve cost attribution include absorption costing, activity-based costing, marginal costing, and process costing. See also cost allocation; cost tracing.

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Cost Assignment at Production Enterprises

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An approach to calculating production costs is outlined. The specifics of calculation are considered for costs of different type. Methods of cost assignment are described.

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Chaika, N.K., Formation of development strategy for industrial enterprise quality, J. Manage. Syst ., 2021, vol. 22, no. 180, pp. 20–26.

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Danilina, M.V., Trifonov, P.V., Surkova, E.V., et al., Managing business in the regions of Russia: Threats’ analysis, Int. J. Econ. Res ., 2017, vol. 14, no. 4, pp. 55–67.

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Activity-Based Costing (ABC): Method and Advantages Defined with Example

what is cost assignment

What Is Activity-Based Costing (ABC)?

Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. This accounting method of costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than traditional costing methods. However, some indirect costs, such as management and office staff salaries, are difficult to assign to a product.

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How Activity-Based Costing (ABC) Works

Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.

Key Takeaways

  • Activity-based costing (ABC) is a method of assigning overhead and indirect costs—such as salaries and utilities—to products and services. 
  • The ABC system of cost accounting is based on activities, which are considered any event, unit of work, or task with a specific goal.
  • An activity is a cost driver , such as purchase orders or machine setups. 
  • The cost driver rate, which is the cost pool total divided by cost driver, is used to calculate the amount of overhead and indirect costs related to a particular activity. 

ABC is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy. 

This costing system is used in target costing, product costing, product line profitability analysis, customer profitability analysis, and service pricing. Activity-based costing is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy. 

The formula for activity-based costing is the cost pool total divided by cost driver, which yields the cost driver rate. The cost driver rate is used in activity-based costing to calculate the amount of overhead and indirect costs related to a particular activity. 

The ABC calculation is as follows:  

  • Identify all the activities required to create the product. 
  • Divide the activities into cost pools, which includes all the individual costs related to an activity—such as manufacturing. Calculate the total overhead of each cost pool.
  • Assign each cost pool activity cost drivers, such as hours or units. 
  • Calculate the cost driver rate by dividing the total overhead in each cost pool by the total cost drivers. 
  • Divide the total overhead of each cost pool by the total cost drivers to get the cost driver rate. 
  • Multiply the cost driver rate by the number of cost drivers. 

As an activity-based costing example, consider Company ABC that has a $50,000 per year electricity bill. The number of labor hours has a direct impact on the electric bill. For the year, there were 2,500 labor hours worked, which in this example is the cost driver. Calculating the cost driver rate is done by dividing the $50,000 a year electric bill by the 2,500 hours, yielding a cost driver rate of $20. For Product XYZ, the company uses electricity for 10 hours. The overhead costs for the product are $200, or $20 times 10.

Activity-based costing benefits the costing process by expanding the number of cost pools that can be used to analyze overhead costs and by making indirect costs traceable to certain activities. 

Requirements for Activity-Based Costing (ABC)

The ABC system of cost accounting is based on activities, which are any events, units of work, or tasks with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. Activities consume overhead resources and are considered cost objects.

Under the ABC system, an activity can also be considered as any transaction or event that is a cost driver. A cost driver, also known as an activity driver, is used to refer to an allocation base. Examples of cost drivers include machine setups, maintenance requests, consumed power, purchase orders, quality inspections, or production orders.

There are two categories of activity measures: transaction drivers, which involve counting how many times an activity occurs, and duration drivers, which measure how long an activity takes to complete.

Unlike traditional cost measurement systems that depend on volume count, such as machine hours and/or direct labor hours, to allocate indirect or overhead costs to products, the ABC system classifies five broad levels of activity that are, to a certain extent, unrelated to how many units are produced. These levels include batch-level activity , unit-level activity, customer-level activity, organization-sustaining activity, and product-level activity.

Benefits of Activity-Based Costing (ABC)

Activity-based costing (ABC) enhances the costing process in three ways. First, it expands the number of cost pools that can be used to assemble overhead costs. Instead of accumulating all costs in one company-wide pool, it pools costs by activity. 

Second, it creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures, such as machine hours or direct labor costs. 

Finally, ABC alters the nature of several indirect costs, making costs previously considered indirect—such as depreciation , utilities, or salaries—traceable to certain activities. Alternatively, ABC transfers overhead costs from high-volume products to low-volume products, raising the unit cost of low-volume products.

Chartered Global Management Accountant. " Activity-Based Costing (ABC) ."

what is cost assignment

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How to Do a Cost-Benefit Analysis & Why It’s Important

Woman Working in Finance

  • 05 Sep 2019

Are you unsure whether a particular decision is the best one for your business? Are you questioning whether a proposed project will be worth the effort and resources that will go into making it a success? Are you considering making a change to your business, marketing, or sales strategy, knowing that it might have repercussions throughout your organization?

The way that many businesses, organizations, and entrepreneurs answer these, and other, questions is through business analytics —specifically, by conducting a cost-benefit analysis.

Access your free e-book today.

What Is A Cost-Benefit Analysis?

A cost-benefit analysis is the process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective.

Generally speaking, cost-benefit analysis involves tallying up all costs of a project or decision and subtracting that amount from the total projected benefits of the project or decision. (Sometimes, this value is represented as a ratio.)

If the projected benefits outweigh the costs, you could argue that the decision is a good one to make. If, on the other hand, the costs outweigh the benefits, then a company may want to rethink the decision or project.

There are enormous economic benefits to running these kinds of analyses before making significant organizational decisions. By doing analyses, you can parse out critical information, such as your organization’s value chain or a project’s ROI .

Cost-benefit analysis is a form of data-driven decision-making most often utilized in business, both at established companies and startups . The basic principles and framework can be applied to virtually any decision-making process, whether business-related or otherwise.

Related: 5 Business Analytics Skills for Professionals

Steps of a Cost-Benefit Analysis

1. establish a framework for your analysis.

For your analysis to be as accurate as possible, you must first establish the framework within which you’re conducting it. What, exactly, this framework looks like will depend on the specifics of your organization.

Identify the goals and objectives you’re trying to address with the proposal. What do you need to accomplish to consider the endeavor a success? This can help you identify and understand your costs and benefits, and will be critical in interpreting the results of your analysis.

Similarly, decide what metric you’ll be using to measure and compare the benefits and costs. To accurately compare the two, both your costs and benefits should be measured in the same “common currency.” This doesn’t need to be an actual currency, but it does frequently involve assigning a dollar amount to each potential cost and benefit.

2. Identify Your Costs and Benefits

Your next step is to sit down and compile two separate lists: One of all of the projected costs, and the other of the expected benefits of the proposed project or action.

When tallying costs, you’ll likely begin with direct costs , which include expenses directly related to the production or development of a product or service (or the implementation of a project or business decision). Labor costs, manufacturing costs, materials costs, and inventory costs are all examples of direct costs.

But it’s also important to go beyond the obvious. There are a few additional costs you must account for:

  • Indirect costs: These are typically fixed expenses, such as utilities and rent, that contribute to the overhead of conducting business.
  • Intangible costs: These are any current and future costs that are difficult to measure and quantify. Examples may include decreases in productivity levels while a new business process is rolled out, or reduced customer satisfaction after a change in customer service processes that leads to fewer repeat buys.
  • Opportunity costs: This refers to lost benefits, or opportunities, that arise when a business pursues one product or strategy over another.

Once those individual costs are identified, it’s equally important to understand the possible benefits of the proposed decision or project. Some of those benefits include:

  • Direct: Increased revenue and sales generated from a new product
  • Indirect: Increased customer interest in your business or brand
  • Intangible: Improved employee morale
  • Competitive: Being a first-mover within an industry or vertical

3. Assign a Dollar Amount or Value to Each Cost and Benefit

Once you’ve compiled exhaustive lists of all costs and benefits, you must establish the appropriate monetary units by assigning a dollar amount to each one. If you don’t give all the costs and benefits a value, then it will be difficult to compare them accurately.

Direct costs and benefits will be the easiest to assign a dollar amount to. Indirect and intangible costs and benefits, on the other hand, can be challenging to quantify. That does not mean you shouldn’t try, though; there are many software options and methodologies available for assigning these less-than-obvious values.

4. Tally the Total Value of Benefits and Costs and Compare

Once every cost and benefit has a dollar amount next to it, you can tally up each list and compare the two.

If total benefits outnumber total costs, then there is a business case for you to proceed with the project or decision. If total costs outnumber total benefits, then you may want to reconsider the proposal.

Beyond simply looking at how the total costs and benefits compare, you should also return to the framework established in step one. Does the analysis show you reaching the goals you’ve identified as markers for success, or does it show you falling short?

If the costs outweigh the benefits, ask yourself if there are alternatives to the proposal you haven’t considered. Additionally, you may be able to identify cost reductions that will allow you to reach your goals more affordably while still being effective.

Related: Finance vs. Accounting: What's the Difference?

Pros and Cons of Cost-Benefit Analysis

There are many positive reasons a business or organization might choose to leverage cost-benefit analysis as a part of their decision-making process. There are also several potential disadvantages and limitations that should be considered before relying entirely on a cost-benefit analysis.

Advantages of Cost-Benefit Analysis

A data-driven approach.

Cost-benefit analysis allows an individual or organization to evaluate a decision or potential project free of biases. As such, it offers an agnostic and evidence-based evaluation of your options, which can help your business become more data-driven and logical.

Makes Decisions Simpler

Business decisions are often complex by nature. By reducing a decision to costs versus benefits, the cost-benefit analysis can make this dilemma less complex.

Uncovers Hidden Costs and Benefits

Cost-benefit analysis forces you to outline every potential cost and benefit associated with a project, which can uncover less-than-obvious factors like indirect or intangible costs.

Limitations of Cost-Benefit Analysis

Difficult to predict all variables.

While cost-benefit analysis can help you outline the projected costs and benefits associated with a business decision, it’s challenging to predict all the factors that may impact the outcome. Changes in market demand, material costs, and the global business environment are unpredictable—especially in the long term.

Incorrect Data Can Skew Results

If you’re relying on incomplete or inaccurate data to finish your cost-benefit analysis, the results of the analysis will follow suit.

Better Suited to Short- and Mid-Length Projects

For projects or business decisions that involve longer timeframes, cost-benefit analysis has a greater potential of missing the mark for several reasons. For one, it’s typically more difficult to make accurate predictions the further into the future you go. It’s also possible that long-term forecasts won’t accurately account for variables such as inflation, which can impact the overall accuracy of the analysis.

Removes the Human Element

While a desire to make a profit drives most companies, there are other, non-monetary reasons an organization might decide to pursue a project or decision. In these cases, it can be difficult to reconcile moral or “human” perspectives with the business case.

A Guide to Advancing Your Career with Essentials Business Skills | Access Your Free E-Book | Download Now

In the end, cost-benefit analysis shouldn't be the only business analytics tool or strategy you use in determining how to move your organization into the future. Cost-benefit analysis isn’t the only type of economic analysis you can do to assess your business’s economic state, but a single option at your disposal.

Do you want to take your career to the next level? Download our free Guide to Advancing Your Career with Essential Business Skills to learn how enhancing your business knowledge can help you make an impact on your organization and be competitive in the job market.

This post was updated on July 12, 2022. It was originally published on September 5, 2019.

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  1. Cost assignment definition

    Cost assignment is the allocation of costs to the activities or objects that triggered the incurrence of the costs. The concept is heavily used in activity-based costing, where overhead costs are traced back to the actions causing the overhead to be incurred. The cost assignment is based on one or more cost drivers. Example of a Cost Assignment

  2. What is Cost Assignment?

    Cost assignment is the process of associating costs with cost objects, such as products, services, departments, or projects. It encompasses the identification, measurement, and allocation of both direct and indirect costs to ensure a comprehensive understanding of the resources consumed by various cost objects within an organization.

  3. Cost Allocation

    Cost Allocation or cost assignment is the process of identifying and assigning costs to the various cost objects. These cost objects could be those for which the company needs to find out the cost separately. A few examples of cost objects can be a product, customer, project, department, and so on.

  4. Cost Allocation

    Cost allocation is the process of identifying, accumulating, and assigning costs to costs objects such as departments, products, programs, or a branch of a company. It involves identifying the cost objects in a company, identifying the costs incurred by the cost objects, and then assigning the costs to the cost objects based on specific criteria.

  5. How to Perform Cost Assignment

    What Is Cost Assignment? The most effective way to discover your true costs is through cost assignment. With the cost assignment method, you factor both direct and indirect costs into the total cost of your specific product or service. Your individual product or service is called a cost object.

  6. Cost Allocation

    Cost assignment involves both cost tracing and cost allocation. Cost tracing encompasses finding direct costs of a cost object while the cost allocation is concerned with indirect cost charge. Steps in cost allocation process Typical cost allocation mechanism involves: Identifying the object to which the costs have to be assigned,

  7. Introduction to Accumulating and Assigning Costs

    Introduction to Accumulating and Assigning Costs What you will learn to do: assign costs to jobs Financial and managerial accountants record costs of production in an account called Work in Process. The total of these direct materials, direct labor, and factory overhead costs equal the cost of producing the item.

  8. COST ASSIGNMENT DEFINITION

    The cost assignment is done through assignment paths and cost drivers. The assignment path identifies the source account (the account whose cost is being assigned "Issue Purchase Orders" in the above example) and destination accounts (the accounts to which the costs are being allocated the various cost objects procured by issuing purchase ...

  9. Cost Accounting: Definition and Types With Examples

    Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing the variable costs of each step of production as well as fixed costs,...

  10. 2.6: Process Costing (FIFO Method)

    2.6: Process Costing (FIFO Method) Another acceptable method for determining unit cost under process costing is the first-in, first-out (FIFO) cost method. Under the FIFO method, we assume any units that were not completed last period (beginning work in process) are finished before anything else is started.

  11. What Is Cost Allocation?

    Cost allocation is the method business owners use to calculate profitability for the purpose of financial reporting. To ensure the business's finances are on track, costs are separated, or...

  12. Cost assignment

    "cost assignment" published on by null. The procedures by which direct or indirect costs are charged to or made the responsibility of particular cost centres, and ultimately charged to the products manufactured or services provided by the organization. Procedures used to achieve cost attribution include absorption costing, activity-based ...

  13. Cost Structure: Direct vs. Indirect Costs & Cost Allocation

    Cost structure refers to the various types of expenses a business incurs and is typically composed of fixed and variable costs, or direct and indirect costs. Fixed costs are incurred regularly and are unlikely to fluctuate over time. Variable costs are expenses that vary with production output.

  14. Cost Accounting: What It Is And When To Use It

    It assigns costs to products, services, processes, projects and related activities. Through cost accounting, you can home in on where your business is spending its money, how much it earns and...

  15. Cost Assignment Flashcards

    Cost assignment of service departments. 1. assign all manufacturing overheads to production and service cost centres. 2. reallocate costs assigned to service cost centers to production cost centers. 3. compute separate overhead rates for each production cost center. 4. assign cost centre overheads to cost objects.

  16. Cost Allocation Methods

    The cost allocation method is a process that facilitates identification and assignment of costs to products, departments, branches or programs based on certain criteria. When the allocation of costs is performed correctly, the business is able to account for its costs as well as trace them back to determine how they are making profits and losses.

  17. Cost Assignment at Production Enterprises

    In cost assignment, the direct and indirect costs associated with production and the provision of work or services are allocated to specific objects (products or contracts). The following methods may be used. 1. Direct assignment: the cost is included directly in the cost of the object on the basis of information regarding the volume and unit ...

  18. Activity-Based Costing (ABC): Method and Advantages ...

    Activity-Based Costing - ABC: Activity-based costing (ABC) is an accounting method that identifies the activities that a firm performs and then assigns indirect costs to products. An activity ...

  19. State the difference between cost allocation and cost assignment

    Cost assignment is the process of allocating costs to cost pools and cost objects either by direct tracing or allocation. Direct tracing is used for allocating direct costs, and allocation is used for indirect costs. While on the other hand, allocating of indirect costs to cost pools and cost objects is known as cost allocation wherein, direct ...

  20. Cost Accumulation: Meaning, Types, and More

    It is a process of accumulating cost information about a particular project or a specific production or product. Under this system, linking and recording the accumulation of direct labor, direct materials, and manufacturing overhead costs happens with respect to the particular job or batch. Also Read: Types of Costing

  21. Cost-Benefit Analysis: What It Is & How to Do It

    Generally speaking, cost-benefit analysis involves tallying up all costs of a project or decision and subtracting that amount from the total projected benefits of the project or decision. (Sometimes, this value is represented as a ratio.) If the projected benefits outweigh the costs, you could argue that the decision is a good one to make.

  22. Cost assignment Definition

    Cost Assignment ‌ Cost assignment is a process that identifies costs with activities, outputs, or other cost objects. Scoping an assessment determines whether or not the knowledge to be assessed is available and sufficient, and therefore represents an important first step in identifying knowledge gaps.

  23. How To Conduct A Cost-Benefit Analysis

    The benefit-cost ratio (BCR) is a numeric comparison that aligns a project's complete benefits with its total costs. It aids in gauging a project's efficiency by quantifying the relationship ...