Question

Discuss the difference between direct costs and allocated costs and why allocated costs are important to include in project costs. Further, and regarding allocated costs, disucss how an organization determines costs to be allocated and the basis of the allocation methodology (i.e. choice of the cost allocation base).

Answer 1

sollution

A Direct cost is a price that can be completely attributed to the production of specific goods or services.

Examples of direct costs are direct labor, direct materials, commissions, piece rate wages, and manufacturing supplies

On the other hand, all the costs which are not tied to a particular cost center or cost object, i.e. it is difficult to trace the cost to a single product, so such cost is called allocated costs (indirect cost)

Examples of allocated costs are production supervision salaries, quality control costs, insurance, and depreciation etc

Differences Between Direct Cost and allocated Cost

The basic differences between direct cost and allocated cost are given as under:

1. The cost which is easily apportioned to a particular cost object is known as Direct Cost. allocated Cost is the cost that can’t be charged to a particular cost object.
2. Direct Cost benefits the single product or project. Conversely, allocated benefits multiple product or projects.
3. The total of all the direct cost results in prime cost whereas the result of all the allocated  cost is known as overheads.
4. Direct Cost is traceable while allocated  is not.
5. Direct cost is subdivided into the direct material, direct labor, direct expenses. On the other hand, allocated cost is subdivided into production overheads, administration overheads, selling & distribution overheads.

Allocated costs are costs that help the company perform its activities .so it is important to include in project costs.

The reporting of the true cost of a program is vital information to any organization that is focused on being financially sound and profitable while accomplishing its mission. Below is a summary of the reasons why cost allocation is important:

1. It determines the true cost of a product or service
2. Helps in generating cost savings by identifying and reducing negative net income programs
3. Helps senior management make more informed strategic and financial decisions
4. Calculates the true amount of fundraising needed to cover all the costs of a program.

cost allocation methods used by each organization depend on its own structure, program & activity.

Allocated costs can be identified and allocated to programs based on a variety of methods. Three common methods are:

1. Personnel. The allocation is based on time spent by employees working on programs. This information can easily be obtained by implementing a timesheet system or by estimating the time.
2. Direct Costs. The allocation is based on total direct costs incurred by each program as a percentage of total direct program costs.
3. Square footage. The allocationis based on square footage occupied by employees. As an example, if the Membership department employs 5 people out of 15 total employees, 33% (5/15) of the total office square footage would be used to calculate allocation costs to Membership.