Cost Allocation
Cost allocation is a financial management technique used by organizations to allocate costs associated with the acquisition of goods and services. It is a method of assigning costs to the activities, departments, or programs of an organization that are related to the production and supply of those goods or services. Cost allocation is an essential part of the budgeting process, as it helps organizations to determine their overall financial position and performance across all units and activities.
Cost allocation can be achieved through a variety of different methods, including direct-expense allocation, indirect-expense allocation, and incremental allocation. These methods vary in terms of the level of accuracy and level of detail in which they allocate costs. Direct-expense allocation, for example, assigns costs directly to the costs of producing the goods or services, whereas incremental allocation assigns costs according to the proportion of resources used in each activity.
Key Features and Considerations
The key features and considerations of cost allocation include:
* Accurately capturing, recording, and allocating costs.
* Creating a comprehensive budget.
* Establishing and utilizing meaningful metrics and key performance indicators (KPIs) to measure the performance of individual activities, departments, or programs.
* Assessing the degree of efficiency or effectiveness of various activities, departments, or programs.
* Establishing and tracking budget allocations and ensuring that goals are met.
Real-World Example
A manufacturing company, for example, has a production department that requires machines, materials, and labor to produce goods and services. The company performs cost allocation to determine how much to allocate to each of these elements (e.g. machines, materials, and labor). It then allocates the production department’s costs accordingly and tracks these costs against its overall budget. Cost allocation in this case allows the company to track its performance and measure its efficiency, which in turn helps it to better manage its budget and resources.
Conclusion
Cost allocation is an essential financial management technique for organizations that is used to allocate costs related to the production and supply of goods or services. It helps organizations to create comprehensive budgets, assess the performance of activities, and track budget allocations against overall goals. Organizations employ a variety of methods to allocate costs, such as direct-expense allocation, indirect-expense allocation, and incremental allocation.