Question

In Accounting, what are the criteria for allocating indirect or common costs?

Also, according to the question, is there any ethical dilemma or ethical issues that as a budget accountant you must consider regarding the Controller's request?

Answer 1

Cost allocation is significantly more straightforward when allocation involves direct rather than indirect costs. The object of cost allocation is to assign costs to one or more specific cost objects or objectives, something that can’t be done with costs such as utility expenses, wages for office administration personnel and business insurance. Despite inherent difficulties, however, there are ways to accurately allocate indirect costs.

Fixed Cost Classification

Fixed cost classification is the simplest way to allocate indirect costs. This method works with costs such as depreciation and labor that can be classified as fixed. Fixed costs are allocated as a fixed charge to a specific business asset or department within the business. For example, depreciation expenses for a trash compactor are allocated to the machine, wages for employees in the receiving department are allocated to the department manager and office supplies expense are allocated according to the department ordering the supplies.

Proportional Allocation

Proportional indirect cost allocation assigns a percentage of an indirect cost to all or several departments within the business. Percentages can be determined each month for each indirect cost but most often are assigned and reviewed annually. The amount each department is charged depends on the type of cost. For example, a heating bill might be allocated according to the number of square feet each department occupies, while a telephone bill -- minus long distance charges that can be traced to a specific department -- might be allocated evenly between every department.

Activity-Based Cost Allocation

Activity-based indirect cost allocation is more time-consuming but is also a more accurate method for allocating indirect costs. It first requires managers to identify and record each business activity a department performs. Activities then are categorized as incurring direct or indirect costs. At the end of reporting period, such as at month's end, records are reviewed, indirect cost rates are calculated and the appropriate indirect costs are allocated.

Cost Rate Calculations

Indirect cost rate calculations can be determined by dividing an indirect cost by a cost object, such as sales revenues or square footage. Indirect cost rates for proportional allocation also can be calculated using an overhead cost calculation. An overall overhead cost rate can be calculated by dividing individual or total indirect costs by the direct costs each department incurs.

Assume, for example, that total indirect costs are $3,000. The printing department has direct costs totaling $4,000, and the mail room has direct costs totaling $2,000 for a combined total of 6,000. Divide $3,000 by $6,000 to get an overhead rate of 50 percent. Then, multiply direct costs for each department to get the total indirect costs to be allocated to each department. In this case, $2,000 of indirect costs are be allocated to the print shop, and $1,000 is allocated to the mail room.

Is there any ethical dilemma or ethical issues that as a budget accountant you must consider regarding the Controller's request?

Yes...! there is a ethical dilemma that as a budget accountant must consider regarding the cotroller's request.