Cost Alocation

1. Introduction 2

2. Purpose of cost allocation 2

To predict the economic effects of 2

Strategic and operational control decisions 2

To obtain the desired motivation and to provide 2

Feedback for performance evaluation 2

To compute income and asset valuations 2

To justify costs or obtain reimbursements 2

3. Types of costs 3

4. Allocation of Service Department costs 3

5. Allocating costs to final product 4

The Traditional Approach 4

ABC Costing 4

6. ABC vs. Traditional costing 4

6. Conclusion 4

Bibliography 5

1. Introduction

The purpose of this paper is two answer two important questions: Why do companies allocate costs? How do companies allocate costs? It is important for the companies to find the proper method to allocate the costs. Cost allocation is an important issue in many companies because many of the costs associated with designing, producing and distributing products and services are not easily identified with the products and services that are created. It would have been easier for companies to allocate cost if costs were directly traceable with the products and the cost allocation would have been minor issue for the company.

2. Purpose of cost allocation

In the past and some even today believed that costs are allocated only for accounting purposes. On the other hand many believe that cost allocation is an important segment in the accounting system of the company since it can help companies 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. According to the authors of the text book there are four majr reasons why company should allocate costs (Horngem et all, 522-523)

To predict the economic effects of

Strategic and operational control decisions

By having proper cost allocation a company will be able