Traditional allocation

Definition

Traditional allocation is a costing method where overhead costs are assigned to products based on a single cost driver, typically direct labor hours or machine hours. It is simpler but may not accurately reflect the actual resources consumed by different products.

5 Must Know Facts For Your Next Test

1. Traditional allocation uses a single predetermined overhead rate to assign indirect costs to products.
2. The predetermined overhead rate is calculated by dividing total estimated overhead costs by the total estimated amount of the cost driver (e.g., direct labor hours).
3. This method assumes that all products consume overhead in proportion to the chosen cost driver, which may lead to cost distortion.
4. Traditional allocation is easier to implement and less costly than Activity-Based Costing (ABC).
5. It works best in environments where production processes are similar and overhead costs are relatively uniform across products.

Review Questions

• How is the predetermined overhead rate calculated in traditional allocation?
• Why might traditional allocation lead to cost distortion?
• In what type of production environment does traditional allocation work best?

Related terms

Predetermined Overhead Rate: A rate used to allocate manufacturing overhead costs, calculated before the period begins.

Activity-Based Costing (ABC): A costing method that assigns overhead and indirect costs to related activities and then allocates them to products based on their consumption of those activities.

Cost Driver: A factor that causes or relates to a change in the cost of an activity or product.