Introduction:
In business, sharing costs and expenses is a common practice. This process is known as cost allocation or cost apportionment. Cost allocation helps businesses to distribute their expenses among different departments, products, or services. In this article, we will discuss the concept of cost allocation and its importance in business.
1. FA – Fixed Asset
Fixed assets are long-term assets that have a useful life of more than one year. These assets include buildings, machinery, equipment, and vehicles. When a company purchases a fixed asset, it incurs a significant cost that needs to be allocated over its useful life. The cost allocation method used for fixed assets is known as depreciation. Depreciation is the systematic allocation of the cost of an asset over its useful life.
2. OH – Overhead
Overhead costs are indirect costs that cannot be directly attributed to a particular product or service. These costs include rent, utilities, insurance, and salaries of support staff. Overhead costs need to be allocated to various departments or products based on their usage. The most common method used for allocating overhead costs is the activity-based costing method.
3. COGS – Cost of Goods Sold
Cost of goods sold (COGS) is the direct cost associated with the production of goods or services. COGS includes the cost of raw materials, labor, and manufacturing overheads. Allocating the cost of goods sold is essential to determine the profitability of each product or service. The cost allocation method used for COGS is the absorption costing method.
4. ABC – Activity-Based Costing
Activity-based costing (ABC) is a cost allocation method that assigns costs to activities based on their consumption of resources. ABC helps businesses to identify the cost drivers of each activity and allocate costs accordingly. ABC is a more accurate method of cost allocation as compared to traditional methods like direct labor or machine hours.
Conclusion:
Cost allocation is an essential tool for businesses to determine the true cost of their products or services. By allocating costs accurately, businesses can make informed decisions about pricing, profitability, and resource allocation. Fixed assets, overheads, cost of goods sold, and activity-based costing are some of the critical concepts related to cost allocation. Understanding these concepts can help businesses to allocate costs effectively and improve their financial performance.