Indirect Costs

At Sunrise Furniture, Sarah, the finance manager, is assigning costs to different products.

She finds that wooden tables and chairs are produced on the same factory floor using shared machines and facilities.

Since both products share the same resources, the company has shared costs like factory rent, equipment maintenance, electricity, and supervisor salaries. These are called indirect costs because they support the production of both tables and chairs rather than just one product.

To estimate product costs accurately, Sarah needs to divide these indirect costs between tables and chairs.

She selects an appropriate allocation base for each indirect cost, depending on how the resource is used.

For example, electricity depends on machine usage, so Sarah uses machine hours as the allocation base.

The company incurs a total electricity cost of five thousand dollars. The machine usage report shows that tables use sixty percent of the total machine hours, while chairs use forty percent.

Using this allocation base, Sarah assigns three thousand dollars of the electricity cost to tables and two thousand dollars to chairs.

This approach helps the company estimate product costs more accurately and make better pricing and production decisions.