Difference Between Cost Allocation and Cost Apportionment

Definition of Cost Allocation and Cost Apportionment

Cost Allocation

Cost Allocation is the process of assigning the costs incurred by a department or activity to the products or services that are responsible for the consumption of these costs. It is used to determine the true cost of producing a product or providing a service, which is essential for pricing, budgeting, and decision-making purposes.

Cost allocation involves identifying the costs that are directly traceable to a particular product or service and allocating these costs on a reasonable basis. Direct costs, such as raw materials and direct labor, are typically easy to allocate. Indirect costs, such as overhead, are more challenging to allocate and are usually divided among products or services using a cost driver, such as machine hours or labor hours.

• Methods of cost allocation include:

1. Direct Method: This method involves assigning costs directly to a particular product or service based on the direct relationship between the cost and the product or service.
2. Step-Down Method: This method involves allocating costs from one department to another and then from one product or service to another until all costs are assigned to the final product or service.
3. Activity-Based Costing (ABC): This method involves identifying the activities that drive the costs and then assigning costs to products or services based on their consumption of these activities.

• Advantages of cost allocation include:

1. Improved cost accuracy: Cost allocation provides a more accurate representation of the true cost of producing a product or providing a service.
2. Better pricing: Cost allocation enables businesses to determine the cost of producing a product or providing a service and use this information to set prices that accurately reflect the cost structure.
3. Better decision-making: Cost allocation provides the information needed to make informed decisions about product lines, pricing strategies, and cost-saving initiatives.

• Disadvantages of cost allocation include:

1. Complexity: Cost allocation can be complex, particularly when allocating indirect costs, which require the use of cost drivers and other methods.
2. Inaccuracy: Cost allocation can be prone to inaccuracies, particularly when the cost driver used does not accurately reflect the consumption of costs by a particular product or service.
3. Increased costs: The cost of conducting a cost allocation study can be substantial, particularly when using advanced methods such as activity-based costing.

Cost Apportionment

Cost Apportionment is the process of dividing a common cost that cannot be directly traced to specific products or services among several cost centers or products based on some agreed-upon basis such as sales, labor hours, or machine hours. This helps in determining the relative share of the common cost that each product or service is responsible for consuming.

Cost apportionment is used when it is not possible to directly assign a cost to a specific product or service. Instead, the cost is divided among several cost centers or products based on some agreed-upon basis. This helps to ensure that the costs are fairly divided among the different cost centers or products.

• Methods of cost apportionment include:

1. Sales-Based Apportionment: This method involves dividing a common cost among several products based on their relative sales.
2. Labor-Hour-Based Apportionment: This method involves dividing a common cost among several products based on their relative labor hours.
3. Machine-Hour-Based Apportionment: This method involves dividing a common cost among several products based on their relative machine hours.

• Advantages of cost apportionment include:

1. Simplicity: Cost apportionment is relatively simple, particularly when compared to cost allocation, as it does not require the use of cost drivers or other complex methods.
2. Fairness: Cost apportionment ensures that common costs are divided among products or services in a fair manner, based on some agreed-upon basis.
3. Cost Transparency: Cost apportionment provides a clear and transparent picture of how common costs are divided among different products or services.

• Disadvantages of cost apportionment include:

1. Inaccuracy: Cost apportionment can be prone to inaccuracies, particularly when the basis used to divide the costs is not an accurate reflection of the consumption of costs by a particular product or service.
2. Limited use: Cost apportionment can only be used for common costs and cannot be used for costs that are directly traceable to a specific product or service.
3. Unfairness: Cost apportionment can result in unfairness if the basis used to divide the costs does not accurately reflect the consumption of costs by a particular product or service.

Difference Between Cost Allocation and Cost Apportionment

Cost Allocation and Cost Apportionment are two related but distinct methods of determining the cost of producing a product or providing a service.

The main difference between the two methods lies in the type of costs being assigned. Cost Allocation is used to allocate costs that are directly traceable to a specific product or service, while Cost Apportionment is used to divide common costs among several products or services.

Cost Allocation is a more complex and detailed process that involves assigning costs using cost drivers and other methods, while Cost Apportionment is a simpler process that involves dividing costs based on some agreed-upon basis such as sales, labor hours, or machine hours.

Cost Allocation provides a more accurate picture of the true cost of producing a product or providing a service, but it can also be more prone to inaccuracies, particularly when the cost driver used does not accurately reflect the consumption of costs by a particular product or service. On the other hand, Cost Apportionment is relatively simple, but it can also result in inaccuracies if the basis used to divide the costs is not an accurate reflection of the consumption of costs by a particular product or service.

Both Cost Allocation and Cost Apportionment have their own advantages and disadvantages and the choice of method depends on the type of costs being assigned and the level of accuracy required.

Conclusion

Cost Allocation and Cost Apportionment are important concepts in cost accounting that are used to determine the cost of producing a product or providing a service. Cost Allocation is used to allocate directly traceable costs to a specific product or service, while Cost Apportionment is used to divide common costs among several products or services.

Both methods have their own advantages and disadvantages and the choice of method depends on the type of costs being assigned and the level of accuracy required. Cost Allocation is more detailed and accurate but can be prone to inaccuracies if the cost driver used does not accurately reflect the consumption of costs. Cost Apportionment is simple but can result in inaccuracies if the basis used to divide the costs is not an accurate reflection of the consumption of costs.

It is important to have a good understanding of both Cost Allocation and Cost Apportionment in order to make informed decisions and effectively manage costs in a business.