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Allocated to department X: ,000 × (3/25) = ,400 Allocated to department Y: ,000 × (22/25) = ,600 You should note the following two important points regarding the cost allocation given in the above example: Many organizations use direct method for allocating departmental costs because it is very simple and easy to employ.The major disadvantage of direct method is that it ignores interdepartmental services and can therefore lead to distorted products and services cost.However, accountants resort to indirect methods such as allocation when they cannot measure resource usage directly.
Cost Assignment Methods
Today’s organizations face growing pressure to control costs and enable responsible financial management of resources.
If the direct method of cost allocation is used, the cost incurred by department A and department B would be allocated to department C and department D only.
The cost of department A and department B would not be allocated to each other even if the two departments provide a significant amount of service to each other.
Under this method, the costs incurred by service departments are not allocated to each other; rather, they are directly allocated to operating departments using some appropriate allocation base.
In other words, we can say that the direct method of departmental cost allocation ignores the service provided by a service department to itself and to other service departments.