Question

Is possible for financial officers to create an adequate allocation base budget for indirect costs?

Answer 1

Cost Accountants Use Allocation Rules to Assign the So-called Indirect Costs. An indirect cost is a shared cost whose benefit is not readily identifiable with a specific program or programs but is necessary to the general operation of the organization. Allocation and apportionment are accounting methods for attributing cost to specific cost objects.

In business, costing means:

• Firstly, finding cost totals for using resources such as human labor, supplies, energy, raw materials, inventory, or support services.
• Secondly, assigning appropriate portions of the totals to individual product units, organizations, or events.

The following are the main steps a finance officer can use when allocating costs to cost objects:

1. Identify cost objects: The first step when allocating costs is to identify the cost objects for which the organization needs to separately estimate the associated cost. Identifying specific cost objects is important because the organization cannot allocate costs to something that is not yet known. The cost object can be a brand, project, product line, division/department, or a branch of the company. The company should also determine the cost allocation base, which is the basis that it uses to allocate the costs to cost objects.

2. Accumulate costs into a cost pool: After identifying the cost objects, the next step is to accumulate the costs into a cost pool, pending allocation to the cost objects. When accumulating costs, you can create several categories where the costs will be pooled based on the cost allocation base used. Some examples of cost pools include electricity usage, water usage, square footage, insurance, rent expenses, fuel consumption, and motor vehicle maintenance.

A cost driver causes a change in the cost associated with an activity. Some examples of cost drivers include the number of machine-hours, the number of direct labor hours worked, the number of payments processed, the number of purchase orders, and the number of invoices sent to customers.