Question

Is it always better to allocate all costs rather than leave them in a lump sum?

Answer 1

The decision on whether to allocate all costs or rather leave them in a lump sum depends on the nature of the financial report we intend to present, the type of the cost, the traceability of the cost element to particular cost object or cost driver etc.

Nature of Report : If we are presenting a consolidated income statement of the company where the earning at the company level is important , then we can present the costs in their respective GL accounts without further alloaction to cost objects or to profit centres.

But when we are presenting departmental or product and service wise income statement or Actibity Based Costing report , or MArginal Costing report or segment profitability report , then we need to allocate the costs which can be traced to a specific cost object or cost driver.

Type of cost : The allocation also depends on the type of cost. If the cost is a relevant cost for any analysis or presentation, we need to allocate that . If the cost is a sunk cost and irrelevant for any analysis of comparative presentation, we can avoid allocating it as it will not make any sense.

Traceability : If we want to allocate a lumsum cost , the cost must be traceable to a particular cost object like product, service, department , market segment etc, or it may be linked to a cost driver so that the cost can be linked to any activity for ABC costing.

Cost allocation generally becomes important for management accounting reports that are greatly helpful to management for decision making in business.