Cost allocation is a crucial aspect of accounting that involves dividing and assigning costs to various departments or products. Cost allocation can be done using different methods, including the cost difference allocation method. This method involves allocating costs based on the differences in costs incurred by different departments or products. In this article, we will explore what cost difference allocation is and how it works.
1. What is Cost Difference Allocation?
Cost difference allocation is a method of cost allocation that involves allocating costs based on the differences in costs incurred by different departments or products. This method assumes that the differences in costs are due to the varying levels of resources used by each department or product. By allocating costs based on these differences, cost difference allocation aims to ensure that each department or product bears its fair share of the total costs incurred.
2. How Does Cost Difference Allocation Work?
To allocate costs using the cost difference allocation method, you need to follow these steps:
Step 1: Determine the total costs incurred.
The first step in cost difference allocation is to determine the total costs incurred by the organization. This includes both direct and indirect costs.
Step 2: Calculate the cost difference.
Next, you need to calculate the cost difference between each department or product and the average cost of all departments or products. This is done by subtracting the average cost from the actual cost incurred by each department or product.
Step 3: Allocate costs based on the cost difference.
Finally, you allocate costs based on the cost difference calculated in step 2. Departments or products with higher costs than the average cost will be allocated more costs, while those with lower costs will be allocated fewer costs.
3. Conclusion
Cost difference allocation is a useful method of cost allocation that ensures each department or product bears its fair share of the total costs incurred. By allocating costs based on the differences in costs incurred, this method provides a more accurate picture of the resources used by each department or product. However, it is important to note that cost difference allocation is just one of many methods of cost allocation, and organizations should choose the method that best suits their needs.