How Do I Create a Cost Allocation Plan?

Osmand Vitez
Osmand Vitez
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Businessman giving a thumbs-up

A cost allocation plan helps a company determine the cost of goods or services produced in standard operations. The plan often focuses on the direct, indirect, and overhead costs needed to manufacture products. A common way to create a cost allocation plan is to review the goods produced, select a cost accounting system, and implement an information system between the company’s operations and accounting department. If a company has no current plan in place, it may take several days or weeks to fully implement a cost allocation system. Management accountants are often useful here to help implement and control this system.

Owners and executives should select a cost application plan only after they review the types of goods produced by the business. The two most common production systems include job order and process costing. In job order systems, companies manufacture products on a singular or batch basis, with each one different in terms of resources used. Process cost systems produce large groups of homogeneous goods in a continuous fashion. The goods that come out of the system are virtually the same in terms of resources and costs used to manufacture them.

Cost accounting systems vary wildly depending operations. While a company can set up something similar to the job order or process system outlined above, other methods, such as activity-based costing or transfer pricing, may work better. Activity-based costing focuses on the use of a cost driver for any activity that increases a product’s cost in the cost allocation plan. Transfer pricing works well for larger businesses that can attach costs to goods as they move through the company’s multiple production departments. The cost allocation plan should clearly define which method would work best.

Another idea for creating a cost allocation plan is the implementation of an information system. This system should electronically transmit data from the operations department to the accounting department. This way, a company allows for real-time information transfer so owners and executives can constantly monitor costs. Manufacturing firms often need copious information on costs so they do not overspend while producing the same amount of goods over time. Management accountants also need this information to produce budgets for the company.

A service-based business can also implement a cost allocation plan. This system will most likely resemble an activity-based costing system. Rather than focus on individual resources to produce a product, it allows the company to focus on business activities. In this manner, a company can assess whether it is overspending for activities that may or may not bring revenue into the company.

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