Cost Allocation and Imputation Itinerary

Unit 4: Cost Allocation and Imputation Itinerary

1. Methodologies for Cost Location

1.1. Based on Functions and Departments

The location of costs, or the itinerary of imputation, aims to find the entity that originates the cost.

In accounting for the presence of indirect costs—which measure resource consumption that cannot be directly traced to the product—it is necessary to find a way of estimating the relationship between the volume of costs and the volume of production. The solution is to set an itinerary of imputation, with different stages represented by cost centers, determining the relationship between resource consumption in the center and the different costs. Costs could be directly allocated to sections or centers or indirectly, using a resource allocation base that expresses the relationship between the cost and the center’s activity level.

As functions are too broad, in management accounting we use sections that are a part of the whole productive process, such as a department, a business unit, or simply a convenience section.

P. Hansen defines sections more precisely as accounts or account schemes that summarize the activity of a function that managers want to control through accounting methods.

The analysis of the location of the costs is essential for at least two reasons:

• Assignment Problem: Guaranteeing the accuracy of cost calculations. The location of costs should allow for the analysis of the indirect costs needed for a concrete production volume.
• Delegation or Accountability Problem: Controlling the efficiency and efficacy of resource utilization by means of a systematic analysis of cost and performance.

1.2. Different Objectives Attributed to Sections

There are two broad methodologies depending on the entity for which the profit is calculated:

• 1st Order Accounting: If the customer order or the product is the cost object and a profit is calculated for them. The objective of including sections is an accurate assignment of indirect costs.
• 2nd Section Accounting: If the parts of the organization or the departments are subject to a profit calculation. Thus, sections can be considered profit centers.