Now, finally, after having talked so much about some important areas of the, and the ideal nature of cost allocation, let's deal with that in the more direct way. So that will be, well it's sort of play on words because we are dealing with indirect cost allocation, and so let's say, clear straightforward way, indirect cost allocation. Again that was structured in the following way. Here I will first introduce what we will do, then we will have a long example that illustrates all that, and then we will wrap up by putting stages. So to some extent what we're doing right now will be repeated with our final episode, but that's done on purpose because like I said, the indirect cost of allocation is by far the most important and the key topic in the General Accounting. First of all, we said that the problem with indirect cost is that they cannot be linked to the cost object and that results in a, basically in a step down or two stage process in which we first associating indirect costs with some cost pools and know with them from these pools we will distribute them. So the first important idea here is cost pools. So, what is a cost pool? So this is an object that accumulates all related costs. Well let me give you an example. The real estate cost pool, so you have a manufacturing process, but you have premises, you have land, you have parking lots, whatever. So you have to somehow deal with that and the way you treat these costs may be somewhat different from the way you treat the costs in the manufacturing processes. So it's worthwhile, first accumulate all costs related to real estate in the manufacturing process to this cost pool. And again, the next thing is that cost pools ideally should be homogeneous. What do we mean by that? That the cause and effect processes within the pool, they should be sort of similar. Remember when I mentioned this real estate cost pool, let's say if you charged indirect costs proportional to the area that is occupied by this or that division, unit, or whatever, then you can see that this cause in the factors sort of similar. So let's say, cause and effect, i'll put similar, it's not the same. Another example, let's say you have two departments: one is payroll, the other is personnel. And then clearly you can see that the costs of both departments they depend upon the number of people that are in the department. So in this case you can say, well you put them together as one pool because the cause and effect in the generation of these costs is kind of similar. So these are the, I would use just this page of flip-chart because the cost pool is an extremely important thing and to some extent we can also say that the cost pool is, also I will put that, cost pool is approximate. This is an intermediary of cost object. So you pool them into one pool and then you will do something else. Let's see what we will do next. Let's put it, cost pool continued. Well, with respect to this pool, we have the problem or task of cost recognition. Remember we said that the cost rule is that you accumulate all costs related to something. Now we have to make sure that we recognize what is related, how much of that is related and how do we do that? Who contributes to that? And first of all we take into account views of people involved, let's say, some people who are involved in the process they have sometimes a better idea of what should be recognized and what should not be recognized. Now that may depend upon, let's say, plant design and procedures. Then it actually takes into account how do products use facilities and resources. Well, that clearly deals with technology. You can say, well, wait a minute technology is everywhere. Well indeed it is. We live in a world in which technology is a key story in almost all business decisions and all business processes. Well, then the next thing, let's say, what types of pools, types of cost pools. Well the main distinction here is the product pools and service pools. For example, the unit producing something is a product pool, while the real estate pool is the service pool or general is the service pool. So basically we can see here that because the pool is an intermediary thing, then we have sort of a step down approach. So first costs go to pools and then from pools they're sort of redistributed. Now the final thing that we study in this part, which is also key to this is the cost base. Well, the cost base has a long definition sort of, it's a factor or a common denominator that allows you to link the cost with that. So basically this is a way to link to the cost to the cost object. And therefore in simple words, for example, let's say you have some indirect cost and then this cost is related to a cost pool. And the cost base is how can we properly quantify that? How, we can say then for the amount of hours of work or the amount of dollars of raw, of direct materials in this case. We will ascribe part of these indirect costs. So this is the idea of the cost base and let's do something, let's add something to this. So cost allocation base versus at what kinds of them maybe or types. Yeah, and let's put them this way. Related to labor, or related to number of people, or related to raw materials, or maybe related to the number of activities and so on and so forth. So there are many ways to actually select this cost allocation base and now we can see the overall ideas. So we first of all measure direct costs, measure all indirect costs and then we start the process of allocation. We first choose these pools, when within these pools, we analyze this cost base and somehow we link parts of these costs to these cost pools. Again this is a story that is easier said than done. And I specifically did that in the following way. In what follows we will study the example of cost allocation of a very simple manufacturing plant that makes badges. So basically they are the unit that makes badges themselves, the other makes clips, then there is some assembly part, and then they use some service pools too. So we will go over all these stages: the initial allocation, then reallocation, and then the calculation of important rates that later will be employed to in order to properly charge indirect costs.
