Activity Based Costing
Introduction The management of costs remains pertinent to the successful operation of any company. To achieve a competitive edge a company must consistently improve their service or product quality, lower their service or product costs, and eliminate services or products that incur profit losses. Using a traditional costing system the portion of overhead costs allocated to the production of a service or product is determined by the total of direct labor hours used in production of the service or product. Companies implement refined cost allocation systems such as the activity based costing method with the intention of helping management strategically plan because these systems provide quality information to help management make informed decisions. In this essay, I will examine the use of cost allocations, the activity based costing method, and how companies can implement and benefit from activity based costing.
Cost Allocations The allocation of costs serves four primary purposes throughout a company. The first is to present the information management needs to make an informed decision. The second is the reduction of non-essential uses of common company resources. The third is to encourage management to assess the efficiency of services provided internally. Finally, the fourth reason is the calculation of the “full cost” of a service or product to be used in price determination and financial reporting (Jiambalvo, 2009). Cost allocation consists of three steps. The first step is the identification of the cost objective. Here it is established which service, product, or individual department needs costs allocated to it. The second step is the formation of individual cost pools. A cost pool is a collection of similar costs that is assigned to an individual allocation base. Finally, the third step is to select an allocation base that relates each cost pool to a cost objective. Ideally, each allocation base should share a common
Cost Allocations The allocation of costs serves four primary purposes throughout a company. The first is to present the information management needs to make an informed decision. The second is the reduction of non-essential uses of common company resources. The third is to encourage management to assess the efficiency of services provided internally. Finally, the fourth reason is the calculation of the “full cost” of a service or product to be used in price determination and financial reporting (Jiambalvo, 2009). Cost allocation consists of three steps. The first step is the identification of the cost objective. Here it is established which service, product, or individual department needs costs allocated to it. The second step is the formation of individual cost pools. A cost pool is a collection of similar costs that is assigned to an individual allocation base. Finally, the third step is to select an allocation base that relates each cost pool to a cost objective. Ideally, each allocation base should share a common
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