Direct Allocation Method
Direct allocation method is a method for cost allocation. In this method, the costs of the manufacturing services department are allocated directly to the production department of the company and to the product itself. This method is one of the simplest cost allocation methods that are used in allocation of the costs in all the companies of the world. Moreover, under this method of cost allocation, the service department’s costs of one department are not allocated to any other service department, no matter the circumstances. Although it may not seem fair to allocate the cost of the manufacturing services such as factory administration and maintenance to the production department, it is actually well justified as to why companies allocate the cost of services to the production.
Purpose of the cost allocation:
Following are the main purposes for allocating the costs in the company:
- This allocations makes the decision-making easier
- It is possible to determine the assets and incomes for the external parties involved
- This method is also used as a justification to the prices charged for the product
- By implying this method of cost allocation, resources can be preserved and costs can be controlled in the right manner
- This method also helps in utilizing the resources to their optimal levels
Methods of cost allocation:
Three methods of cost allocation in total of which the method of direct allocation is the most useable are as follows:
- Direct allocation
- Step down method
- Reciprocal method
The reason for the allocation of these service costs are that these service departments do not produce goods that can be sold. Therefore, these departments cannot justify the cost they have incurred. This is why their costs are allocated to the production department.
Example:If the manufacturing service department incurs the costs of $20000, then these costs are allocated to the different departments with the ratio with which these departments have used the support of the manufacturing service department. When the costs are allocated, this helps in the setting the prices for the new product. With the help of this method, all the costs incurred in preparation of the product are accounted properly.
Start free ReadyRatios
reporting tool now!
- Debt ratios
- Liquidity ratios
- Profitability ratios
- Asset management ratios
- Cash Flow Indicator Ratios
- Market value ratios
- Financial analysis
- Business Terms
- Financial education
- International Financial Reporting Standards (EU)
- IFRS Interpretations (EU)
- Financial software