It is important for management to understand how different departments and customers contribute to the profitability of a company. Profitability is comprised of both price and costs. Costs can be allocated using a variety of methods. Understanding cost flows and the various methods of allocating costs is important in ensuring profitability.
Evaluate potential cost allocation methods that would impact an organization’s selling prices, and provide examples.
Communicate decisions faced when collecting and allocating indirect costs to customers, and provide examples.
Elaborate on why costs for one customer might be different from that for another customer being sold the same product or service.
Full Answer Section
The impact of these methods on selling prices will vary depending on the product or service being produced, the cost structure of the company, and the competitive environment. In general, methods that allocate more costs to products or services will result in higher selling prices.
Decisions faced when collecting and allocating indirect costs to customers
When collecting and allocating indirect costs to customers, there are a number of decisions that need to be made, including:
- Which costs should be allocated to customers?
- How should the costs be allocated?
- What are the criteria for allocating costs to customers?
- How often should the costs be allocated?
The decisions about which costs to allocate to customers will depend on the specific business and the types of costs that are incurred. Some common costs that are allocated to customers include:
- Sales commissions
- Customer service costs
- Shipping costs
- Marketing costs
- Administrative costs
The method for allocating costs to customers will also depend on the specific business and the types of costs that are incurred. Some common methods for allocating costs to customers include:
- Direct tracing: This method allocates costs directly to the customers that benefit from the costs. For example, sales commissions can be directly traced to the customers that made the sales.
- Rational allocation: This method allocates costs based on a rational basis, such as the number of units sold or the number of customer service calls.
- Arbitrary allocation: This method allocates costs based on an arbitrary basis, such as the number of customers or the total sales.
The criteria for allocating costs to customers will also need to be determined. Some common criteria include:
- The benefits received by the customers
- The ability of the customers to bear the costs
- The fairness of the allocation method
The frequency of allocating costs to customers will also need to be determined. Some companies allocate costs to customers on a monthly basis, while others allocate costs on a quarterly or annual basis.
Why costs for one customer might be different from that for another customer being sold the same product or service
There are a number of reasons why costs for one customer might be different from that for another customer being sold the same product or service. Some of the most common reasons include:
- The volume of purchases: Customers who purchase larger volumes of products or services typically receive a lower price per unit.
- The location of the customer: Customers who are located in remote areas may incur higher transportation costs.
- The payment terms: Customers who pay their bills late may incur late payment fees.
- The credit risk: Customers with poor credit histories may be charged higher prices to cover the risk of non-payment.
- The level of service: Customers who require a high level of service, such as custom orders or expedited delivery, may be charged higher prices.
It is important to note that these are just some of the factors that can affect the cost of goods sold for different customers. The specific factors that affect costs will vary depending on the industry and the specific business.
Sample Answer
Potential cost allocation methods that would impact an organization’s selling prices
There are many different cost allocation methods that can be used, and the impact on selling prices will vary depending on the method chosen. Some of the most common cost allocation methods include:
- Direct labor hours: This method allocates costs based on the number of direct labor hours used to produce a product or service. This method is simple to calculate and understand, but it may not be accurate if the direct labor hours do not accurately reflect the cost of production.
- Machine hours: This method allocates costs based on the number of machine hours used to produce a product or service. This method is more accurate than direct labor hours if the machines are a major cost driver, but it can be more difficult to calculate.
- Direct materials costs: This method allocates costs based on the amount of direct materials used to produce a product or service. This method is easy to calculate and understand, but it may not be accurate if the direct materials costs do not accurately reflect the cost of production.
- Cost-of-goods-sold: This method allocates all costs associated with the production of a product or service, including direct labor, direct materials, and overhead costs. This method is the most accurate, but it can be the most complex to calculate.