Traditional Allocation Method

Definition

The Traditional Allocation Method is an approach to overhead cost allocation that assigns indirect costs to cost objects, such as products or services, based on a single allocation base, typically direct labor hours or machine hours. This method aims to distribute overhead costs in proportion to the level of activity or resource consumption of the cost objects.

5 Must Know Facts For Your Next Test

1. The Traditional Allocation Method uses a single overhead cost pool and a single allocation base, such as direct labor hours or machine hours, to distribute overhead costs to cost objects.
2. This method assumes that the relationship between overhead costs and the allocation base is linear, meaning that as the allocation base increases, the overhead costs increase proportionally.
3. The Traditional Allocation Method is relatively simple to implement and understand, but it may not accurately reflect the true cost of producing a specific cost object if the relationship between overhead costs and the allocation base is not linear.
4. The Traditional Allocation Method is often used in organizations with relatively homogeneous products or services, where the relationship between overhead costs and the allocation base is relatively straightforward.
5. The predetermined overhead rate is calculated by dividing the estimated total overhead costs by the estimated total allocation base, such as direct labor hours or machine hours.

Review Questions

• Explain the process of calculating predetermined overhead and total cost under the Traditional Allocation Method.
  • Under the Traditional Allocation Method, the predetermined overhead rate is calculated by dividing the estimated total overhead costs by the estimated total allocation base, such as direct labor hours or machine hours. This predetermined overhead rate is then applied to the actual allocation base for each cost object to determine the overhead cost assigned to that cost object. The total cost of a cost object is then calculated by adding the direct costs and the allocated overhead costs.
• Discuss the advantages and limitations of the Traditional Allocation Method compared to other cost allocation methods.
  • The advantages of the Traditional Allocation Method include its simplicity, ease of implementation, and familiarity in many organizations. However, this method has limitations in that it assumes a linear relationship between overhead costs and the allocation base, which may not always be accurate, particularly in organizations with diverse product lines or complex overhead cost structures. Other cost allocation methods, such as Activity-Based Costing, may provide more accurate cost information by considering the actual drivers of overhead costs.
• Analyze the situations in which the Traditional Allocation Method may be most appropriate and the factors that would suggest the need for a more sophisticated cost allocation approach.
  • The Traditional Allocation Method is most appropriate in organizations with relatively homogeneous products or services, where the relationship between overhead costs and the allocation base is relatively straightforward. However, in organizations with diverse product lines, complex overhead cost structures, or significant differences in the way overhead costs are consumed by different cost objects, a more sophisticated cost allocation approach, such as Activity-Based Costing, may be necessary to accurately capture the true cost of producing each cost object. Factors that would suggest the need for a more sophisticated approach include the presence of significant indirect costs, a wide variety of products or services, and significant differences in the way overhead costs are consumed by different cost objects.

Related terms

Overhead Costs: Overhead costs are indirect costs that cannot be directly traced to a specific cost object, such as rent, utilities, and administrative expenses.

Cost Allocation: Cost allocation is the process of assigning indirect costs to cost objects, such as products or services, based on a predetermined allocation method.

Direct Labor Hours: Direct labor hours are the total number of hours spent by employees directly working on the production of a specific cost object.