Internal cost allocation: simply abolished!

Internal cost allocation as a bazaar? – Not a fantasy.

A central task of cost accounting is to allocate the costs incurred to the products as accurately as possible. For example, when bicycles are assembled, the costs for the purchased lighting system, brakes and tyres can be easily allocated.

But what about the costs for IT, HR, logistics/customs or order processing? These services are necessary for the ongoing operation of a company. However, they cannot be allocated to a single bicycle. Cost accountants and controllers have therefore developed allocation methods to allocate these costs sensibly.

How does this work in practice? In one example, the manager of a workshop wants to hire a new employee. The workload is good. He needs more manpower. The workshop manager therefore requests support from the HR department at the head office.

Basically, he wants nothing more than to fulfil his production targets. That’s why he wants a simple, transparent and fast process. He certainly has little interest in describing the services he needs in detail and negotiating prices.

But this is exactly what is happening, as a look at practice shows.

What is fair is in the eye of the beholder

Even if the internal line billing is correct and in line with the source, it can still be criticised. This is because accuracy is usually achieved at the cost of complicated and time-consuming calculations – which can even lead to mismanagement in individual cases.

Where people work together for years, relationships also develop – leaving the door open for individual negotiations and discussions about “right” and “fair” prices. Such scenarios also lead to resentment.

How is it possible against such a background

• A noticeable reduction in the workload of those involved and a reduction in the cost of exchanging services.
• More flexibility and simplification with regard to planning, reporting, processes, financial statements and systems.
• Maintaining transparency in contribution margin accounting.
• Fulfilment of legal requirements and
• a high level of acceptance among the workforce

Internal cost allocation – radically simple

Some are daring to test a bold scenario in which internal services are no longer charged at all. For management and service recipients, such a regulation is a positive thing. However, critical questions from service providers and accounting departments are not long in coming: won’t the regulation lead to an “all-inclusive mentality” on the part of service recipients?

Practice shows a different result: on the service provider side, there is an increased awareness of costs. In the classic cost accounting model, the service providers divide the costs into small units and charge them to the service recipients on demand. The total amount of costs is thus lost sight of.

The reorganisation provides greater motivation for efficiency, as the responsibility for costs in the new model lies at the point of origin, i.e. with the service providers.

Replacement sizes

With the end of internal cost allocation, values are lost for which a replacement must be created:

• In the new scenario, product prices are calculated from the direct production costs plus a production overhead surcharge. The production managers can focus on their own production costs. Direct costs and overheads are clearly separated.
• For strategic decisions on “make or buy”, investments and the relocation of product lines within the Group, it makes sense to use the total costs of ownership. This means that not only the acquisition costs, but also the costs of subsequent utilisation are included. The necessary costs for buildings and infrastructure are thus taken into account.
• Intercompany settlements, i.e. services between independent group units, are calculated using the simplified procedure proposed by the OECD for “low-value-adding services”. These services relate to services that are not part of a company’s core business.

The allocation key proposed by the OECD is calculated using the formula “volume per country plus 5 per cent profit mark-up”. Goods flows can also be valued according to this model. The simplification fulfils the tax law requirements of IC offsetting.

Accompanying costs of the changeover

Converting the cost accounting system is a change project. The project requires comprehensive communication support so that employees understand it, help to shape it and make it their own. The loss of information during the transition from the old to the new system should not be underestimated: the old system is no longer complete and the new one is not yet fully effective. Management must be aware of this.

Cost accounting CKL Software

No matter how you set up your cost accounting: CKL is at your side. Our app for Microsoft Dynamics 365 Business Central adapts flexibly to your needs, for example by separating fixed and variable amount components or setting up any number of overhead calculation schemes. Learn more about the highlights in one of the upcoming webinars.