Activity Based Costing

Abstract

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 based costing (ABC)

COST ALLOCATION AND ACTIVITY BASED COSTING PRACTICES 3

Cost Allocation and Activity Based Costing Practices

Cost allocation techniques are the cornerstone of a firm’s financial management practices. It has a tremendous effect on the decision making processes within the firm, and affects the information reported in a company’s financial statement issued to outside users and investors. It informs the managers about the areas within a firm’s operations that are generating the costs, and provides insights on ways a manager can evaluate the cost generators, and bring about efficiency in the process so as to boost a firm’s profit. The traditional cost allocation method although widely used has some deficiencies, and some of it was addressed by the advent of activity based costing method (Chea, 2011).

Allocation of cost not only provides information on a firm’s business activities, it encourages restraint on the part of users of the cost generating activities. Assignment of cost to departments requesting support for goods or services minimizes the overuse or illegal use of that cost driver for other non-sanctioned business activities. This restrain not only pushes managers for greater efficiency in their sections or...