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~ Primary Costs and Secondary Costs

Primary Cost:

  • A primary cost is a direct cost that can be directly traced to a specific product or service. Examples include direct labor costs, direct materials costs, and direct manufacturing overhead.

Secondary Cost:

  • A secondary cost, also known as an indirect cost or overhead cost, is a cost that cannot be directly traced to a specific product or service. Examples include rent, utilities, and administrative salaries.

FSVs and Cost Centers:

  • Primary Cost and Cost Center: When posting a primary cost, it's typically necessary to specify a cost center to allocate the cost to the appropriate department or production unit. This is because primary costs are directly related to specific activities or products.
  • Salary and Department: Salary is considered a secondary cost, as it's not directly traceable to a specific product or service. However, it's often allocated to departments or cost centers based on the employee's role or responsibilities. This is done to track the cost of labor within different areas of the organization.

In summary, the statements you've been told about FSVs and cost centers are consistent with standard accounting practices. By ensuring that primary costs are allocated to specific cost centers and that salaries are assigned to appropriate departments, you can gain valuable insights into the cost structure of your organization and make informed business decisions. 

Connecting primary costs to specific cost centers is crucial for understanding the cost burden of each department or unit. This information is essential for effective cost management and decision-making.

Here's why it's important:

  • Cost Allocation: By associating primary costs with cost centers, you can accurately allocate costs to the departments or units that consume those resources. This helps to identify areas where costs are high and where there may be opportunities for improvement.
  • Performance Evaluation: Knowing the cost burden of each department allows you to assess its performance and compare it to other units. This can help to identify departments that are more efficient or less efficient in their use of resources.
  • Decision Making: The cost burden information can be used to make informed decisions about resource allocation, pricing, and product mix. For example, if you know that a particular department has a high cost burden, you may need to consider ways to reduce costs or increase revenue.

As you mentioned, allocating secondary costs can be more challenging. Secondary costs, such as rent or utilities, are often shared by multiple departments. There are various methods for allocating these costs, such as:

  • Square footage: Allocating costs based on the amount of space each department occupies.
  • Direct labor hours: Allocating costs based on the number of labor hours worked in each department.
  • Revenue: Allocating costs based on the revenue generated by each department.

The most appropriate method for allocating secondary costs will depend on the specific circumstances of your organization.

In conclusion, connecting primary costs to cost centers is a fundamental step in cost management. By accurately allocating costs and understanding the cost burden of each department, you can make more informed decisions and improve the overall efficiency and profitability of your organization.



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