What is Cost Allocation? How to Allocate Costs?

Cost allocation

Costing Allocation

Cost Allocation is the process of assigning costs to appropriate cost objects. Cost objects can be any activities or items that you want to measure cost separately. A product, product line, customer, department, etc. can be classified as cost objects.

According to Generally Accepted Accounting Practices, it is necessary to match costs with the revenue. Cost allocation plays an important part in this. It is also used for preparing financial reports. It helps to calculate the profitability of various cost objects like products, departments, sales regions, etc.

Types of costs.

Business owners incur different types of costs while running a business which includes inventory, rent, salary paid for the employees, equipment maintenance, etc. But in the end, All the expenses are categorized into three.

  1. Direct Cost.

Direct costs are those costs that are directly connected to your cost object and its production. These costs need not be allocated but it helps to determine the cost of the products or services that are sold. Raw materials for production, manufacturing supplies and wages to a direct employee who is working in the assembly line are considered direct costs.

  1. Indirect costs.

Indirect costs are not directly connected to the cost objects but it is necessary for the smooth operations of a business. It includes utilities, maintenance charges for equipment, and wages paid to supervisors or anyone who works in the factory but not in the product line.

  1. Overhead Costs

Overhead costs are not really a part of producing goods or services but can benefit the business as a whole. These costs include marketing expenses, human resources, insurance, rent, office supplies, etc. Overhead costs will also need to be allocated to determine the cost of the product or services.

The ultimate aim of cost allocation is to assign the cost in the best way possible to meet the desired outcome. Business owners should have aware of various costs that affect their goods or services while determining the actual product cost. Allocation of costs will make this process much easier. You can also help you makes better financial decisions and uncover various challenges faced by your business.

How to Allocate Costs?

Identify cost objects

The first step of allocating costs is identifying your cost object. Anything that generates expenses within your business can be considered a cost object. You will have to understand and review each product, product line, department, and sales region to list down all of your cost objects.

Categorize your cost.

Once you get a detailed list of cost objects. You should gather a detailed list of all the costs that are incurred by your business. It should include insurance, utilities, square footage, or any other costs that your business incurs

Allocate costs

You can start allocating your costs once you have the list of your cost objects and a list of all the costs your business incurs. You should add up all the cost that affects each cost object which can include direct material, labor costs, and overhead costs to get the total cost of that specific cost object.

If you think you need assistance with allocating your business costs. Feel free to reach out. Our expert accountants can provide end-to-end assistance. Get in touch with us to know more.

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