Definition: A common cost is an expense associated with operating a facility, product, or segment that is shared between two or more departments or users. In other words, it’s a shared expense of creating a product or providing a service that can’t be attributed to a single department or user.
What Does Common Cost Mean?
Common costs must be allocated equitably to all of the users that share the expense based on the cost object. This treatment is far better for each department involved because their shared costs are much lower than the total expense associated with the activity if they were required to pay for it individually.
Let’s look at an example.
Bill is the CEO of a small product company in Seattle that has to visit two different suppliers for two different products Bill’s company produces. One is in Germany and the other is in Canada. The plane ticket to Germany is $2,000 and the ticket to Canada is $500. If Bill buys one ticket with a stop in Canada, he can reduce his costs to $2,000 thus saving his company $500 on the total trip.
Common costs are typically assigned or allocated to joint products, processes, and activities, so the company can accurately determine the cost of each activity and adjust prices accordingly. In this case the joint activities are trips to different suppliers related to different department. Now what product should these travel costs be associated with?
The answer is both. They are shared costs because the trip benefited both product departments and cost objects. By booking the flights together, Bill was able to lower the overall expenses of the trip and lower the expenses that each department will have to pay. Bill can use either the stand-alone cost allocation method or the incremental cost allocation method to assign these travel costs to each department.