Chapter 6 Cost allocation and Activity-Based-Costing

Chapter 6 Cost allocation and Activity-Based-Costing -...

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    Chapter Six Cost Allocation and  Activity Based Costing
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    Objectives 1. Explain why indirect costs are allocated and describe the cost allocation process. 2. Discuss allocation of service department costs. 3. Identify potential problems with cost allocation. 4. Describe activity-based costing (ABC) and cost drivers .
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    Purposes of Cost Allocation
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    Rationale #1: To Provide Information for Decision Making From a decision making standpoint, the allocated cost should measure the opportunity costs of using scarce company resources.
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    Rationale #2: To Reduce Frivolous Use of Common Resources If costs are not allocated, these resources appear “free” to the users. But scarce resources never come with zero costs.
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    Rationale #3: To Encourage Evaluation of Services The flip-side of the previous point (to reduce frivolous usage); is to compel the current users to evaluate the costs and benefits of the services for which they are being charged (assuming they have a choice of using more or less of it).
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    Rationale #4: To Provide Full Cost Information 1. GAAP requires full-costing for external reporting purposes. 2. In the long-run, all costs must be covered. Therefore even committed fixed costs that are beyond the control of a manager may have to be allocated to products.
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    Full cost allocation example: How might you allocate Depreciation of the  building in which products is produced.  Suppose your company produces 15 different  product lines. How much depreciation do you  assign to each product? Answer : maybe you assign it based on floor  space used for each product. 
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    Full Cost allocation and the product life  cycle. Your company develops a new software product X.   The actual production cost of the units is very low.  Most of the cost is the “fixed cost” of developing the  product and introducing it to the market. Product development is carried out by the  engineering department, and promotion by the  marketing department. They are involved with many  products. We may need to allocate some of these department  costs to X in order to find out if it will be profitable or  what price we need to charge.
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    Process of Cost Allocation Steps include: Identify the cost objectives (the targets of allocation) Form cost pools and select the allocation base which relates the cost pools to the cost objectives.
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    Process of Cost Allocation
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  Determining the Cost Objective Cost Objective: Determine the product, service or department that is to receive the allocation. On the next slide we see some examples.
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This note was uploaded on 12/01/2011 for the course ACCOUTNING 5302 taught by Professor Newman during the Fall '05 term at Bauer College of Business.

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Chapter 6 Cost allocation and Activity-Based-Costing -...

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