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    Cost Allocation Activity Based Costing

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    Saurabh Singh
    This document discusses cost allocation and activity-based costing (ABC). It explains that indirect costs are allocated to provide information for decision making, reduce frivolous resource use, and encourage service evaluation. The cost allocation process involves determining a cost objective, forming cost pools, and selecting an allocation base. ABC identifies activities that cause overhead and assigns costs using cost drivers rather than assuming proportional volume-based allocation. ABC provides more accurate costing but is more complex than traditional methods.

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    Cost Allocation Activity Based Costing

    Uploaded by

    Saurabh Singh
    18 views20 pages
    This document discusses cost allocation and activity-based costing (ABC). It explains that indirect costs are allocated to provide information for decision making, reduce frivolous resource use, and encourage service evaluation. The cost allocation process involves determining a cost objective, forming cost pools, and selecting an allocation base. ABC identifies activities that cause overhead and assigns costs using cost drivers rather than assuming proportional volume-based allocation. ABC provides more accurate costing but is more complex than traditional methods.

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    Managment

    Original Title

    Cost Allocation Activity Based Costing

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    This document discusses cost allocation and activity-based costing (ABC). It explains that indirect costs are allocated to provide information for decision making, reduce frivolous resource use, and encourage service evaluation. The cost allocation process involves determining a cost objective, forming cost pools, and selecting an allocation base. ABC identifies activities that cause overhead and assigns costs using cost drivers rather than assuming proportional volume-based allocation. ABC provides more accurate costing but is more complex than traditional methods.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    18 views20 pages

    Cost Allocation Activity Based Costing

    Uploaded by

    Saurabh Singh
    This document discusses cost allocation and activity-based costing (ABC). It explains that indirect costs are allocated to provide information for decision making, reduce frivolous resource use, and encourage service evaluation. The cost allocation process involves determining a cost objective, forming cost pools, and selecting an allocation base. ABC identifies activities that cause overhead and assigns costs using cost drivers rather than assuming proportional volume-based allocation. ABC provides more accurate costing but is more complex than traditional methods.

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    © All Rights Reserved
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    Download as ppt, pdf, or txt
    of 20

    Cost Allocation & Activity Based Costing

    LO1-Explain why indirect costs are allocated

    LO2- Describe the cost allocation process

    LO3- Identify potential problems with cost allocation

    LO4- Discuss activity-based costing (ABC) and cost drivers

    LO5- Distinguish activity-based costing (ABC) from activity-based


    management (ABM)
    Purposes of Cost
    Allocation
    Purposes of Cost
    Allocation
    Provide information for decision making
    – Allocated cost should measure the opportunity cost of
    using a company resource

    – In practice, difficult to operationalize since cost may


    quickly change

    – Provides a useful benchmark


    Purposes of Cost
    Allocation
    Reduce frivolous use of common resources
    – Frivolous use may have hidden cost such as slower service

    – Allocation of centrally provided services provides incentive


    for departments to reduce frivolous use of resource
    Purposes of Cost
    Allocation
    Encourage evaluation of services
    – If costs are not allocated, there is no incentive to evaluate
    the services and look for lower cost alternatives

    – With cost allocation, there is a strong incentive to critically


    evaluate the efficiency and necessity of services
    Purposes of Cost
    Allocation
    Provide “full cost” information
    – GAAP requires full costing for external reporting purposes

    – Full cost information is needed when the company has an


    agreement whereby revenue received depends upon cost
    incurred, i.e.“cost-plus” contracts
    Process of Cost Allocation

    • Determine the cost objective


    • Form cost pools
    • Select an allocation base to relate cost pools
    to the cost objective
    Process of Cost Allocation
    Determine the Cost Objective

    • Determine the product, service, or department that


    is to receive the allocation. Object of the allocation
    is called the cost objective

    • For example, if computer costs are allocated to


    contracts, the contracts are the cost objective
    Cost Objectives
    Allocating Budgeted and Actual
    Service Department Costs
    • Management should allocate based on budgeted
    costs rather than actual costs

    • Allocation of actual amounts allows service


    department to pass on cost of inefficiencies and
    waste to production departments
    Problem of Using Measures of Production
    Volume to Allocate Overhead
    • Typical allocation bases include direct labor hours
    and machine hours
    • Assumes all overhead costs are proportional to
    production volume
    • When OH costs not proportional to production
    volume:
    - High-volume products are overcosted
    - Low-volume products are undercosted
    Activity-Based Costing
    • Identifies major activities that cause overhead costs
    to be incurred
    • Cost of resources consumed performing these
    activities grouped into cost pools
    • Costs are assigned to products using a measure of
    activity, i.e. cost driver
    The ABC Approach
    Common Activities and
    Associated Cost Drivers
    Activity Based Costing-
    McMaster Screen Technologies
    Benefits of ABC
    • Provide more accurate costing
    - Less likely to undercost/overcost due to cost driver usage

    • May lead to improvements in cost control


    - Costs broken out into a number of activities rather than
    into one or two overhead cost pools
    Limitations of ABC
    • More costly to develop and maintain than a
    traditional costing system

    • Used to develops full cost of products


    - Includes fixed costs
    - Lacks incremental information necessary for
    decision making
    Activity-Based
    Management
    Appendix
    • The steps in activity-based management are:
    1. Determine major activities
    2. Identify resources used by each activity
    3. Evaluate the performance of the activities
    4. Identify ways to improve the efficiency and/or
    effectiveness of the activities

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