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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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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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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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