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Cost allocation incorporates the process of accumulating, identifying, and assigning a cost to the objects. These objects include products, departments, company branches, or program. It calculates the cost which is incurred by the above-mentioned objects while running the processes are carrying out operations. Cost is assigned to these cost objects as per certain criteria. Knowing cost allocation is mandatory in the case of financial students to understand the profitability as well as cost reduction schemes followed in a company. When cost allocated to objects certain factors are brought into consideration. These factors determine what amount of costs to be allocated to which object. Is a fund is also created in case there is a shortage of cost after the allotment process?
Cost allocation plays an important role in organizations to make a profit or suffer loss. If in any case, the cost allocation goes wrong then the company may require allocating more resources to yield the expected output or meet their profit demand.
An organization allows various types of cost two objects some of them are as follows.
Direct cost is involved in the production of a particular good or service. They are not assigned to an object; henceforth whatever the cost is incurred is transferred to the departments as per requirement. It can be understood by an example, the salaries paid to workers under specific departments that are not to be allocated again as they have already been mentioned under the Department Head.
This cost is indirectly related to the direct cost. Costs that are incurred for running company operations and maintaining the harmony and health of the organization are included under indirect cost. Examples of indirect costs are security cost, administration cost, risk cost, etc. Indirect costs have to subcategories that are fixed indirect cost and variable indirect cost. The cost that is fixed for a department or a certain product is known as fixed cost such as remuneration given to the project supervisor of the production department. Whereas, indirect variable cost changes with change in the level of output produced.
These are the indirect costs that are not included under manufacturing or production cost. They do not have any relation to the material or labour cost incurred in the process of production of goods and services but they only support the selling processes of commodities and services. They are attached as an expense that is to be paid continuously even if the organization does not sell any goods or services. An example of overhead cost is postage and printing, utilities, rent expenses, etc.
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