Cost Allocations & Activity Based Costing (ABC)
The cost allocation is a process of assigning costs to different activities. There is several methodology of cost allocation. The cost driver allocates costs into different activities and locations. Health organizations use different allocation methods according to their needs to attain organization and profitability. The purpose of allocation is to make the understanding of costs easier rather than rating the products and services. Another purpose is to compute and analyze asset evaluation. The allocation of cost to service department helps attribute and facilitate costs. There are three types of cost allocation methods: step down, direct costs and reciprocal method. The paper also discusses the Activity Based Costing methodology which allocates cost to activities from gathering overhead.
Cost allocation is the process of assigning the indirect costs of producing a product. These indirect costs may be shared by multiple products. Indirect cost is assigned to different products, services or health departments. Unlike cost rating, cost allocation is less concerned with the actual amount of cost but more about how to assign the cost to different locations. Direct costs can be physically traced to each health department and indirect cost must be allocated. Health organizations accumulate costs for their product or services for financial reporting services. Increasingly the health care company manages costs and profitability of their customers. A cost driver is that has a logical, cause and effect relationship to the cost will be used as a cost-allocation base. Health care organizations of all types engage in cost allocation. Businesses use allocation methods as a tool for planning and controlling their budgets needs. In this paper, cost allocation methods. Also, we will discuss the implementation of ABC methodology of cost allocation, its strength and weaknesses, efficiency gains, profitability implications, and cost and benefits (Toktay, 2011). Costs are usually divided into three main categories which are direct material, direct labor and overhead costs. It is very easy to calculate direct labor, direct materials. Overhead costs are usually hard to calculate. Overhead costs are not easily managed (Toktay, 2011). Cost allocations tend to solve the problem of linking the costs and grouping one costs with other and dividing them into sub—divisions. So linking such costs with the cost objectives through cost drivers is called the process of cost allocation. For example major cost such as newsprint for newspaper and direct labor for law firm may be allocated to departments, jobs and products (Toktay, 2011).
A cost pool is a group of individual costs that is allocated to cost objectives using a single cost driver, divisions, projects and jobs. Other costs might not be the major direct costs which are not important enough for justifying their allocations individually. All costs in a given pool should have the same cost driver, so each cost driver allocations have several costs (Toktay, 2011).
Purpose of Allocation
Health care managers within an organizational unit should be aware of their decisions, even consequences outside of their unit. Costs are allocated for several reasons. First purpose of cost allocation is to obtain the desired results or motivations. The health finance management is influenced by cost allocation. Some health firms do not have cost allocations in internal auditing or internal management while in other there is cost allocation in the upper management. Cost allocation in lower management is for making sure the benefits of services or goods exceeds the costs allocated (Caplan, 2011). Another purpose of cost allocation is to compute income and asset evaluation. Cost of goods sold and inventory cost needs to be determined through means of cost...
References: 1-Toktay, B. (2011). Cost allocation in manufacturing–remanufacturing operations . Production and operation managment, Retrieved from http://onlinelibrary.wiley.com/doi/10.1111/j.1937-5956.2011.01236.x/abstract
2-Caplan, D. (2011). Management accounting: Concepts and techniques . College of Buisness, Retrieved from http://classes.bus.oregonstate.edu/fall-06/ba422/Management Accounting Chapter 12.htm
3- The Economist. (2009, June 29). Activity-based costing. Retrieved from http://www.economist.com/node/13933812
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