Concepts Underlying Cost Allocations

Concepts Underlying Cost Allocations - CONCEPTS UNDERLYING...

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CONCEPTS UNDERLYING COST ALLOCATIONS The underlying concepts of cost allocations relate to the purposes of assigning costs to cost objects as well as the principles, or supporting logic for the cost allocation methods chosen. PURPOSES OF COST ALLOCATIONS The purposes of cost allocations are closely related to the purposes of information systems outlined. Cost allocations are needed to value inventory for external reporting purposes, for planning and monitoring the cost of activities and processes, and for various short term and long term strategic decisions. Some examples include decisions to "make or buy" sub-components and services, how to price products and services, when to add or discontinue various products and services and when to expand or contract the size of a segment of the company. Cost allocations are also needed to support a price when "cost-plus" pricing is used, as in government contracting, and in situations where costs must be justified before reimbursement can be obtained, as in Medicare reimbursements to medical facilities. In addition, since cost allocation methods are components of the overall performance evaluation system, cost allocations tend to influence the behavior of the participants within the system. Therefore, system designers must also carefully consider the motivational, or behavioral aspects of alternative cost allocation methods. THE SUPPORTING LOGIC OF COST ALLOCATION METHODS From the perspective of the matching concept, (i.e., matching cost and benefits) it is logical to allocate a cost to the object (e.g., user, activity, department, product) based on a "cause and effect" relationship. The idea is to allocate the cost to whatever causes, or drives the cost. If the driver for a cost cannot be identified, or identified easily, then an allocation scheme perceived to be "fair and equitable" might be used. A search for a "fair and equitable" allocation method often leads the system designer to the "ability to bear" the cost logic. Some examples that most readers can relate to include allocating the costs of federal, state and local governments to their constituents. Federal and state income taxes are based on the "ability to bear" logic, i.e., they are progressive in that those with higher incomes pay a higher percentage of their incomes than those with lower incomes. On the other hand, gasoline taxes are based on the "benefits received" logic because these taxes are used to maintain the highway infrastructure (e.g., roads, bridges, lighting, traffic signs, signals and highway patrols) for those who use the highways. Whether either of these tax allocation schemes is also "fair and equitable" is subjective and therefore controversial. For example, those who pay little or no income taxes tend to receive the greatest benefits in the form of welfare and other government transfer payments. Some observers say this is fair, while others voice the opposite viewpoint. Gasoline
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This note was uploaded on 04/03/2012 for the course ACCT 325 taught by Professor Warren during the Spring '08 term at Rutgers.

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Concepts Underlying Cost Allocations - CONCEPTS UNDERLYING...

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