In our previous blog in the Cost Allocation Uncovered series, we went in-depth on 7 critical cost allocation methods, from Indirect and Direct Costing to Rate-Based ABC. In this article, you can learn a few more advanced terms and concepts in this area, expanding from what you’ve already read.
This piece follows a short-form format in order to effectively define the key terms in cost management. Many of these terms are defined in-house by CostPerform Experts, so they are practical in developing your cost allocation understanding.
Note: There can always be a difference of opinion on key terms. One team uses the term “cost allocation” as another uses “activity-based costing”. We use standard terms that will be broadly understood, but may not always be the exact term used in your company.
Key Terms and Advanced Methods in Cost Allocation:
Indirect Allocation Method: You determine how to assign the costs of an overhead, like HR expense, throughout your organization
Direct Cost Allocation: You assign costs straight to the cost objects, skipping any complicated intermediate steps.
Step-Down Method: You allocate service department costs to other departments one at a time, following a set sequence. Read more on this method of cost allocation.
Reciprocal Method: With the reciprocal method, you can allocate costs in two directions, i.e. an HR department uses IT resources, and vice versa.
Activity-Based Costing (ABC): With the ABC method, you track specific activities that drive expenses and allocate costs based on actual usage, not just broad categories.
Job Order Costing: This is when you allocate costs to each project or job based on the exact resources it consumes.
Process Costing: You spread costs evenly over all units produced, making it ideal for mass production environments.
Absorption Costing: You ensure every unit produced absorbs all manufacturing costs, both fixed and variable.
Variable Costing: You focus only on variable costs when allocating expenses, treating fixed costs separately as period costs.
Dual Rate Cost Allocation: You separate fixed and variable costs, then allocate them using different methods to get a clearer picture.
Equitable Allocation: You distribute costs based on fairness rather than rigid formulas, which works well in partnerships and joint ventures.
Standard Costing: You set predetermined cost estimates, then later compare them to actual costs to adjust for variances.
Time-Driven Activity-Based Costing (TDABC): You use time as the key driver, making cost allocation more dynamic and accurate.
Revenue-Based Allocation: You assign costs based on how much revenue each segment brings in, keeping things proportional.
Machine-Hour Allocation: You distribute costs based on machine usage, which is perfect for automated manufacturing.
Employee-Hour Allocation: You allocate costs according to labor hours worked, making it great for service-based industries.
Network-Costing: Industry specific, the cost of hosting a network in terms of infrastructure in telecommunications or utilities
Long-Run Incremental Costing (LRIC): Industry specific, relating to cost allocation in telecoms, LRIC helps determine the cost of providing an additional unit of service over the long run, as production scales.
Bill-of-Materials: A term used in manufacturing and similar industries in costing the total input costs for a specific good
Cost-to-Serve: Similar to the above, an industry specific term used in government cost allocation, logistics and other services. A total cost figure for a set customer, product, or department.
Funds Transfer Pricing (FTP): Used in banking and financial services costing. How you allocate the cost of funds across different business units.
Pool-Based FTP: You assign a single transfer rate to a group of similar assets and liabilities instead of individual pricing.
Matched-Maturity FTP: You match asset and liability cash flows to allocate costs based on their duration and risk.
Multiple-Pool FTP: You create different transfer pricing pools based on factors like risk, maturity, or business line.
How to Improve Your Costing Knowledge and Educate Your Team
Concepts like Network Costing, Funds Transfer Pricing and Time-Driven Activity-Based Costing are critical knowledge in understanding how to effectively allocate and deeply understand enterprise financial activities, depending on your industry. To learn more about the fundamental concept of cost allocation, read our overview.
You can also read CostPerform’s examples of cost allocation. If you’re interested in creating a more in-depth training environment for your team, the CostPerform Academy is a resource provided free of charge. For any other queries on learning, our CostPerform team will be happy to help.
