IntroductionCost allocation, also known as expense allocation or cost apportionment, refers to the process of distributing expenses among different departments, product...
Introduction
Cost allocation, also known as expense allocation or cost apportionment, refers to the process of distributing expenses among different departments, products, or services in a company. This is done to accurately reflect the true cost of each department, product, or service and to facilitate decision-making.
Types of Cost Allocation
Direct cost allocation: This method assigns costs directly to a specific cost object, such as a product or department. For example, if a company produces two types of products, Product A and Product B, and incurs $10,000 in direct labor costs for each product, then $10,000 will be allocated to Product A and $10,000 will be allocated to Product B.Indirect cost allocation: This method assigns costs that cannot be directly traced to a specific cost object. Indirect costs are typically shared by multiple cost objects and need to be allocated based on some criteria, such as usage, square footage, or headcount. For example, if a company incurs $100,000 in rent expense for a building that houses three departments, then the rent expense needs to be allocated among the three departments based on their respective usage of the building.Step-down cost allocation: This method allocates indirect costs in a sequential manner, starting with the department that incurs the highest amount of indirect costs and ending with the department that incurs the lowest amount of indirect costs. This method recognizes that some departments may provide services to other departments, and therefore, their indirect costs should be allocated first before allocating the remaining indirect costs to other departments.Benefits of Cost Allocation
The benefits of cost allocation include:
Accurate cost determination: Cost allocation helps to determine the true cost of each department, product, or service by including both direct and indirect costs.Fairness and transparency: Cost allocation ensures that each department, product, or service is charged only for the costs that it incurs, which promotes fairness and transparency in decision-making.Cost control: Cost allocation provides a clear picture of the costs associated with each department, product, or service, which enables managers to identify areas of high cost and take appropriate actions to reduce them.Conclusion
In conclusion, cost allocation is an important tool for accurately determining the true cost of each department, product, or service in a company. By using various methods of cost allocation, such as direct cost allocation, indirect cost allocation, and step-down cost allocation, managers can make informed decisions about resource allocation, pricing, and cost control.