Common Costs

Common costs are costs that are shared by several products, processes, departments, or territories at the same time, rather than being traceable directly to any single one of them. Because no single cost object can claim exclusive responsibility for a common cost, it has to be divided up through allocation using some reasonable basis before each product or department's full cost can be determined.

A factory's heating bill is a common cost shared by every department housed in the building; a shared manufacturing facility's rent is a common cost of every product line produced there; and the cost incurred before several products emerge from a joint production process is a common cost of all the resulting products, often called a joint cost in that specific context. In each case, the cost exists regardless of which individual product, department, or territory is examined, making it impossible to assign without choosing some allocation method.

Allocation bases for common costs are chosen to approximate cause and effect as closely as possible: a heating bill might be allocated based on square footage occupied, a joint production cost might be allocated based on each resulting product's relative sales value, and shared administrative costs might be allocated based on headcount or revenue of each department being charged. No allocation basis is perfectly precise for a genuinely common cost, since by definition it could not be traced directly to any single object in the first place.

A direct cost can be traced to a specific product or department without any allocation judgment at all, while a common cost always requires some allocation decision, which introduces an element of management judgment into the resulting reported cost of each individual product or department. This is one reason cost accountants distinguish so carefully between the two categories when building product costing systems, since treating a genuinely common cost as if it were directly traceable would misrepresent how the business actually incurs its costs.

Because common costs typically continue to exist regardless of what happens to any single product or department sharing them, managers evaluating whether to discontinue a product line need to distinguish the allocated share of common costs from the product's genuinely avoidable, direct costs, since eliminating a product rarely eliminates the common costs it had been allocated a share of, a distinction that is central to sound decision-making analysis.

A shared factory incurs $300,000 in annual rent, used by three product lines occupying 50%, 30%, and 20% of the floor space respectively. Allocating the common rent cost by square footage would assign $150,000 to the first product line, $90,000 to the second, and $60,000 to the third, even though none of the three products alone caused the full rent obligation to exist.

Because no single, objectively correct way exists to divide a common cost, the choice of allocation basis — square footage, headcount, machine hours, or revenue generated — can meaningfully shift how profitable each product, department, or customer appears to be, even though the company's total cost and total profit remain exactly the same regardless of which basis is chosen. This is precisely why common costs are sometimes called unallocable or joint costs in management discussions: allocating them is a useful planning and pricing exercise, but the resulting per-product or per-department cost figures should never be mistaken for costs that would actually disappear if that one product or department were eliminated, since the underlying common cost, like the factory's rent, would simply have to be reallocated across whatever remains.