The importance of proper allocation of costs cannot be overstated for any firm whether it is a small, medium, or large multinational firm. Cost allocation plays a major role in the decision making processes of executives, managers and supervisors in their tasks of managing a firm’s business activities. Cost allocation also plays a role in a firm’s quest for profitability and investors’ confidence in the executives and managers of a firm and the long-term viability of a firm. Effective cost allocation can provide a competitive edge to an organization in globalized and competitive nature of current business environment.
Keywords: Traditional cost allocation method, activity ...view middle of the document...
This restrain not only pushes managers for greater efficiency in their sections or department, but it can also push the organization towards profitability.
A real world example is in my current role as procurement agent for my employer which is a network health care provider for veterans. All equipment, goods and service requested by a department in the facility is charged to that department’s fund control point, which is basically the department’s quarterly budget. The department administrative officer has access to monitor the fund level, but not to move funds around or acquire goods and services on his or her
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own. This system provides an understanding of cost allocation to the departments, with the true cost of their requests for services, processes and products (Chae, 2011) from the acquisition and material management section and is matched against their budgeted quarterly funds.
Traditional Coast Allocation Method
The traditional method of allocating costs consists of three steps in order to achieve the desired results (Jiambalvo, 2013) these step includes the identification of the cost objectives, forming of cost pools and selecting and matching of the cost pools to the cost objectives. Following these steps are important to ensure that a firm understands the processes and products that are supposed to receive the allocation of costs
Cost Objective Identification. The identification of a cost objective provides a clear recipient for the allocation of costs. In a manufacturing firm like Intel which manufactures central processing units (CPU) that powers personal computers, enterprise servers and some mobile devices. The set up cost of setting up a fabrication factory for chip production is enormous. The different models of CPU chips which are the final products are in this case the cost objectives receiving the cost allocation. For a service oriented firm like Ernst & Young, the cost objective can be different audits, examination and consulting work done on behalf of a client
Cost Pools. Cost pools are formed by combining related cost generating business activities that can be allocated to a cost objective using a common base .Making sure that the pool consist of comparable costs is important (Jiambalvo, 2013), to avoid the distortion of the allocation. For Intel a cost pool might contain the set up cost of preparing machinery for production processes, pay and compensation for the employees involved in the set up section,
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cost of tools and supplies used in the set up process. For a service firm like E&Y, the pools can consist of , cost of office supplies, Enterprise IT (EIT) costs used to provide services for the clients (Kocakulah, Humphrey, & Long, 2012), and employee wages.
Allocation Base. The cost allocation is a business item that is common...