Jiambalvo_Ch 6_Cost Allocation & ABC_Bathala_Apr 2009

Jiambalvo_Ch 6_Cost Allocation & ABC_Bathala_Apr...

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MGMT 640 Jiambalvo Text Commentary by Chenchu Bathala The chapter starts with a simple but very relevant example concerning the issues in cost  allocations confronted by Ben Jakes, CFO, Gardenrite. One issue relating to the traditional  approach to cost allocations is the assumption that overhead costs are proportional to the  production volume which may not be the case in every situation. A newer approach, Activity- based costing (ABC) overcomes this issue in addition to its flexibility for use in service firms,  not-for-profit businesses, and even government.  Purposes of Cost Allocation Illustration 6-1 in p. 211 and the discussion in the following pages explain the different reasons  why firms allocate costs along with relevant examples. 1) To provide information for decision making : The divisional level profit is impacted by the  costs allocated to them. In order to minimize such cost allocations, it is important that the  divisional managers communicate the impact of additional production on their cost structures.  This leads to the concept of the “opportunity cost” in the use of company resources. The art  department’s example in p. 211 clearly explains this concept and its implication for cost  allocations – with and without the existence of excess capacity.  2)  To minimize frivolous use of resources : Frivolous use of resources could be a serious  problem if costs of commonly available resources are not allocated to the departments using  such resources. This is similar to the “free rider” problem that we know and is typically 
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This note was uploaded on 02/14/2011 for the course MGMT 640 taught by Professor Bathala during the Summer '09 term at UMBC.

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Jiambalvo_Ch 6_Cost Allocation & ABC_Bathala_Apr...

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