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Allocation of Fixed Costs

According to Leitner (2007, p.1), activity- based-costing is different from other methods of cost allocation in that costs are assigned to the various production processes rather than using normal conversion costs which include factory overhead and labor. The costs are allocated directly to the product through allocation methods. This is different from other costing methods which utilizes machine hours or direct labor. ABC costing system breaks down the various overhead costs incurred in the production process. When using ABC costing method, the entire production process is divided into various core activities. This means that cost objects in ABC method are broadened compared to traditional costing methods (Edwards, Hermanson & Invacevich, 2007, p.37). Secondly, the cost for the respective core activities identified is defined. The third step entails allocating costs to the respective products depending on the amount of activity required in order to produce the particular product.

ABC costing system is characterized by five main steps as outlined below:

  1. Identification of cost drivers.
  2. Formation of a cost pool where the various costs are collected around their respective drivers.
  3. Determination of the level of every activity.
  4. Allocating cost to products.

Integration of Activity-based-costing as a costing method can be of great benefit in the operation of organizations. This arises from the fact that organizations can be able to enhance their performance by reducing costs. Through ABC costing method, firms’ management team can be able to track resource consumption. According to Barnett (2007, p. 32), costs within an organization indicate the degree of complexity and diversity in the firm’s production process. Additionally, a high degree of competence within the organization’s operations is also attained. This arises from the fact that management teams can be able to identify how particular activities are linked and demand that they impact on the organization’s resources (Walter, 2011, p.270).

Through ABC costing method, a firm can be able to make effective business decisions by eliminating idle capacity. ABC method also enables management accountants overcome deficiencies associated with traditional costing methods. This arises from the fact that ABC costing method enables managers to align the various activities with the products. ABC costing enables management accountants to have a greater visibility on how the firm’s profitability is impacted by the customers, products and the supply channel. A firm’s management team can also be able to identify divisions that result into high profit or loss.

Firms that utilize the ABC costing system include the manufacturing companies. An example of such a firm is Hewlett Packard Incorporation which deals with the manufacture of computer and computer accessories.

According to Warren (2008, p.371), manufacturing systems are increasingly becoming complex. As a result, there is a high probability of distortion in the allocation of cost. Incorporation of ABC method enables manufacturing firms to avoid this distortion. Through integration of ABC costing system, Hewlett Packard has been able to control the various costs associated with the diverse production activities. Currently, the firm has managed to attain an optimal market position globally.

Reference List

Barnett, I. (2007). Management accounting performance evaluation. Oxford: Elsevier.

Edwards, J.D., Hermanson, R.H. & Invacevich, S.D. (2007). Accounting principles: a business perspective. Managerial. Georgia: University of Georgia.

Leitner, A. (2007).Activity based costing. New York: Munchen GRIN Verlag GmbH.

Walter, L.M. (2011). Principles of accounting. Utah: Utah State University.

Warren, C.(2008). Survey of accounting. Mason, Ohio: South-Western Cengage Learning.

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