Posted in Finance, Accounting and Economics Terms, Total Reads: 1945
Definition: Fully Allocated Cost
It refers to cost of a product or service that’s incurred in producing or imparting a particular product or service. It’s a top-down costing approach.
It includes direct as well as indirect costs associated with the product or service:
1. Direct cost: It includes costs that can be directly traced to the product/service e.g. direct labor, direct material etc. These are variable costs, hence as the quantity increases, total direct cost also increases.
2. Indirect cost or overhead: It includes costs that can’t be directly traced but can be assigned based on certain measures like labor hour, labor cost, machine hour etc. These are portion of fixed cost or administrative cost that remains same for a range of production. Overhead costs are distributed to per unit of product.
The main advantage of FAC comes from its simplicity as it is easy to verify during audits. Its drawbacks come from the arbitrary practice of allocating overheads in real life. It may result in high overhead allocation for some products and less for others. Also, it’s difficult to say what constitutes as direct and indirect cost, leading to arbitrary allocation. Even, the use of historical data may result in higher overhead allocation that in fact decreased after use of better technology.
Example: Suppose, for producing 100,000 pencils, the cost of direct material and labor are Rs 0.50 and Rs 0.30 respectively. Also fixed cost of the machine is Rs 100,000 and only 20% of fixed cost can be allocated to pencil making. The fully allocated cost of one pencil will be equal to,
FDC = direct labor + direct material + overhead = 0.50 + 0.30 + (20% of 100,000)/100,000 = 0.50+0.30+0.20 = Rs 1 per pencil