The purpose of this paper is to answer a few important questions: Why do companies allocate costs? How do companies allocate costs? And how this cost allocation can affect the decision making of the company. 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. The decision-making process, is heavily relied on the information the company has received from the cost allocation process. By having all the correct information available, decision-making becomes an easier task and having the incorrect information can be affect the company for months or even years. But first let’s talk about cost accounting, cost allocation and it’s purpose. Cost/ Managerial accounting
Managerial accounting is concerned with providing information to managers, this information is for those who are inside the organization and who direct and control its operations(Managerial Accounting and Managerial Accounting Practices). Managerial accounting can be contrasted with financial accounting, which is concerned with providing information to stockholders, creditors and others who are outside an organization. Managerial accounting includes things like budgeting, information on the cost of a companies goods or services and performance reports. These reports provide information on how well the company is proforming by comparing actuals to budgets and/or benchmarks. Other analytical reports are perpared to investigate specific problems such as a decline in profitability of a product ( Ray H. Garrison, Eric W. Noreen and Peter C. Brewer p 1). Yet other reports analyze other business situation or opportunities. Purpose of cost allocation
A cost is generally understood to be an expense incurred in an economic activity to achieve a specific product or service. All types of businesses, not-for-profits, governmental agencies have costs. To achieve a goal or objective, an organization acquires resources, transforms them in some manner, and delivers units of product or service to its customers. Costs are incurred to perform these activities. For planning and control, decisions are made about areas such as pricing, product costing, outsourcing, and investments. Different costs are needed for different purposes. In each instance, costs are determined to help management make better decisions for the company or agency(Business and Finance, 2008). 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. When incurred, costs are initially reviewed by the accounting system and the accounting staff to classify the type of expense. Costs with one or more characteristics in common may be accumulated into cost pools(Business and Finance, 2008). Costs are then reclassified to the correct expense account, from these cost pools to one or more cost objects. A cost object is an activity, a unit of product or service, a customer, another cost pool, or a segment of an organization for which management needs a separate measurement and accumulation of costs (Business and Finance, 2008). There are different classifications of costs as when a company decides on a product or services we split those costs into manufacturing costs and nonmanufacturing costs ....
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