Direct or variable costs
Some costs relate directly to a product and this is quite straightforward in principle, although very detailed record-keeping may be necessary.
Among the costs that can be entirely allocated to individual products are
- direct wages and associated employment costs,
- materials and bought-in components.
Other costs do not relate to just one product and these must be allocated according to a fair formula.
These indirect costs must be absorbed by each product.
There is not a single correct method of allocating overhead costs to individual products and it is sometimes right to allocate different costs in different ways.
The aim should be to achieve fairness in each individual case.
Among the costs that cannot be entirely allocated to individual products are
- indirect wages (cleaners, maintenance staff, etc.),
- wages of staff such as salesmen and accountants, and
- general overheads such as rent and business rates.
Take care to allocate non-direct costs fairly
Great care must be taken in deciding the best way to allocate the non-direct costs.
There are many different ways.
The following two are common methods:
- Production hours
- Machine hours
Common Methods for allocating non-direct costs fairly