What is an Applied Cost?

An applied cost is an indirect cost that has been applied to a cost object, such as a product, department, or activity. An applied cost is not directly needed to construct a product or provide a specific service, but is required for the overall operation of a business.

How a Cost is Applied

A predetermined allocation rate is typically used to assign costs to cost objects. The allocation rate is based on the planned amount of the cost pool and a planned activity level. If the actual costs and production volumes turn out to be different, an adjustment to the allocation rate may be made partway through the year. This allocation is required by most accounting frameworks (such as GAAP and IFRS) to ensure that the cost of all inventory is fully loaded with overhead costs.

Examples of Applied Cost

There are numerous cases in which applied costs are used within a business. Here are several examples:

Factory overhead cost application. A manufacturing firm estimates its factory overhead costs and production volume for the upcoming year and divides the planned volume by the planned overhead costs to derive an allocation rate. This rate is then applied to the units produced in the upcoming year, thereby increasing the recorded cost of each unit. If one of the units is subsequently sold, then this cost is charged to expense through the cost of goods sold. Or, if the units are still on hand at the end of the year, then their cost, including the applied cost, will be recorded within ending inventory.
Service department cost application. There may be several departments within a business that provide services to other departments, such as the janitorial department and the IT department. The cost to operate these departments can be applied to other departments based on their rates of usage. For example, the cost of a janitorial department can be applied to other departments based on the square footage that must be cleaned within each department.