Is Direct-labor cost the best cost-allocation base?

Answer 1

This is a vague question because "cost allocation", in principle, is dependent on what cost is being allocated. The general purpose of cost allocation is to distribute cost to some object based on an equitable, consistent set of rules. Generally, the objects are fairly homogeneous and share the costs according to some correlated attribute. Characteristics such as whether the objects (products or services) are produced in a continuous or discrete production process, i.e., mass produced versus custom products, are important in determining the basis of allocation. The best practice is to identify all costs (labor, materials, machinery, facilities, etc) that can be costed directly to the object. The next allocable costs are those most easily identifiable to a specific product. In other words, some indirect costs are more readily associated with Product A versus Product B. The objective of any costing system is to assign cost in the most precise manner possible so that pricing and profit decisions are accurate. The most difficult costs to assign are management, general and administrative, and other "non-productive" costs. The answer as to whether direct labor is the best basis for cost allocation is most dependent on the proportion of direct labor costs to other direct costs and whether the indirect costs are driven by the volume (hours) or value ($) of direct labor. A capital intensive manufacturing process utilizing expensive machinery may be best served by allocating indirect costs based on machine time versus human time. This is just an example. To say is there a best way is probably not the right question. There are many ways and are all dependent on the specifics of the business.