Cost of allocation methods a cost benefit decision

This preview shows page 7 - 9 out of 22 pages.

Cost of allocation methods; A Cost-benefit decisionThe choice of whether to use a plantwide rate or departmental rates depends on the products andthe production process. If the company manufactures products that are quite similar and that usethe same set of resources, the plantwide rate is probably sufficient. If multiple products use themanufacturing facilities in many different ways, departmental rates provide a better picture of theuse of manufacturing resources by the different products. Selecting more complex allocationmethods requires more time and skill to collect and process accounting information. Such asincremental costs of additional information must be justified by an increase in benefits fromimproved decisions.Activity-Based CostingActivity-based costing (ABC) is a two-stage product costing method that assigns costs first to activitiesand then to the products based on each product’s use of activities. An activity is any discrete taskthan an organisation undertakes to make or deliver a product or service. Activity-based costing isbased on the concept that products consume activities and activities consume resources.Developing Activity-Based CostsActivity-based costing involved the following four steps;1.Identify the activities—such as processing orders—that consume resources and assign coststo them.2.Identify the cost driver(s) associated with each activity. A cost driver causes, or ‘drives’, anactivity’s costs. For the order-processing activity, the cost driver could be the number oforders.3.Compute a cost rate per cost driver unit or transaction. The cost driver rate could be the costper order, for example. Predetermined rates for allocating indirect costs to products arecomputed as follows;Estimated indirect costpredetermined rate = -------------------------------------------------------------------estimated volume of allocation base4.Assign costs to products by multiplying the cost driver rate by the volume of cost driver unitsconsumed by the product. For example, the cost per order multiplied by the number oforders processed for a particular song during the month of March measures the cost of theorder processing activity for that song during March.Cost HierarchiesThe differences between activity-based costing system and the two-stage cost flow, include;In activity-based costing system, the first-stage allocates costs to activities, not departmentsThe difference of the cost drivers, the cost drivers were direct labour- and machine-hours,both of which are production-volume or simply volume related. That is, both cost drivers areproportional to production volume.
The distinctive feature of activity-based costing is that it recognises that overhead costs arecaused by activities and that some activities are driven by something other than productionvolume.

Upload your study docs or become a

Course Hero member to access this document

Upload your study docs or become a

Course Hero member to access this document

End of preview. Want to read all 22 pages?

Upload your study docs or become a

Course Hero member to access this document

Term
One
Professor
N/A

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture