Introduction:
In business, cost allocation is an important aspect that helps companies determine the true cost of their products or services. One common method of cost allocation is to distribute the costs among different units or products based on their usage or consumption. In this article, we will discuss how cost allocation can be done by distributing it into the unit price.
1. What is Cost Allocation?
Cost allocation is the process of assigning indirect costs to different units or products. Indirect costs are those costs that cannot be directly traced to a specific product or service. Examples of indirect costs include rent, utilities, and salaries of support staff. Cost allocation is necessary because these indirect costs need to be accounted for in order to determine the true cost of each product or service.
2. Methods of Cost Allocation
There are different methods of cost allocation, including the direct method, step-down method, and reciprocal method. The direct method allocates costs directly to the products or services based on their usage. The step-down method allocates costs from one department to another in a sequential manner. The reciprocal method considers the mutual services provided by different departments and allocates costs accordingly.
3. Distributing Costs into Unit Price
One way of allocating costs is by distributing them into the unit price. This method involves adding a percentage of the total indirect costs to the direct costs of each unit or product. For example, if the total indirect costs are $10,000 and the company produces 1,000 units, then the cost per unit would be $10 ($10,000/1,000). If the direct cost per unit is $50, then the total cost per unit would be $60 ($50 + $10).
4. Advantages of Distributing Costs into Unit Price
One advantage of this method is that it simplifies the cost allocation process. Instead of allocating costs to different units or products, the costs are distributed evenly based on the production volume. This method also provides transparency in pricing as customers can see the breakdown of costs in the unit price.
5. Disadvantages of Distributing Costs into Unit Price
One disadvantage of this method is that it may not accurately reflect the actual usage of indirect costs by each unit or product. For example, if one unit consumes more utilities than another unit, then the cost allocation based on production volume may not be fair. Another disadvantage is that it may not encourage cost reduction efforts as the costs are already distributed evenly among all units or products.
Conclusion:
Cost allocation is an important aspect of business that helps companies determine the true cost of their products or services. There are different methods of cost allocation, including distributing costs into the unit price. While this method has advantages such as simplifying the cost allocation process and providing transparency in pricing, it also has disadvantages such as not accurately reflecting the actual usage of indirect costs and not encouraging cost reduction efforts. Companies should carefully consider the pros and cons of each method before deciding which one to use.