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let’s first try to understand the subject.
- Cost allocation
Cost allocation is the process to assign cost to product or services. It can also be defined as the process of finding cost of different objects in an organization such as a project, a department, a customer, a branch etc. While assigning cost, it is important to understand whether it is a direct or indirect cost. The treatment of both the cost is different and it will help the management to deal with the particular cost accordingly. Cost allocation should ensure that the cost allocated is complete, actually incurred and recorded in the financial statement. Classifying business expense into direct or indirect cost is important as it helps company price their product and also file their taxes properly.
- Direct cost
Manufacturing cost can be defined as a direct cost. A direct cost can be associated with specific product or activity. Examples of direct cost are direct materials, commissions, manufacturing supplies, direct labour etc. These costs are used to prepare specific product or services and are easily traceable. An example of a direct cost would be plastic. It is possible to calculate how much plastic was used to prepare 1000 plastic bottles. Direct cost can be further divided into a fixed and variable cost. Fixed cost doesn’t change where as a variable cost may change depending upon the requirement of production or increase in the price of any product or service.
- Indirect cost
These are the cost which cannot be directly attributed to any product or service but are incurred for the normal operations of the company. However, indirect cost is considered to understand and arrive at the total cost of the product or service and to determine the selling price of that particular product or service. Examples of indirect costs are maintenance cost, material handling cost, rent, utilities etc.
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