Allocating Fixed Costs

Allocating Fixed Costs

Introduction

A financial analyst is supposed to undertake different accounting techniques to analyze accounting figures. The accounting treatment of cost is very complex and has financial significant. The Chartered Institute of Management Accountants (CIMA) defines cost accounting as a process of accounting for costs from the point at which its expenditure is incurred or committed to the establishment of the ultimate relationship with cost units. The cost accounting assist management in gathering information required to take various decisions.

Activity Base Costing

The accounting concept name “Activity Base Costing” is pretty much defined by its name. Basically, it is costing based on activity. It is a system in which costs and staff timing are produced by breaking down every activity into its component parts to assess the amount of work and time involved. It helps in attributing cost to all activities within organization and measures amount of resources required to undertake specific part of work. Therefore, the activity-based accounting is a comprehensive method for determining accurate costs for each and every activity that is involve in manufacturing of particular product whether directly and indirectly. Among costing system the activity based accounting system is relatively recent and widely accepted by organizations worldwide (Willard, 1922).

In order to develop activity-base accounting system, we have to identify the relationship between activities, resources and service and product. Organization used to spend their resources on activities and the product or service is the outcome of these activities. Organization undertakes many operational activities to manufacture product and use different types of resources in these operational activities. The usage of these resources can be tracked in a way that which product or service consumes what amount of resources. The resources can be identified as direct labor cost or direct material cost. It is a fact that most of the overhead costs are related to the product directly or indirectly. The overhead costs are the organizational resources which are spent on producing final product or these resources are used for facilitating the manufacturing process (Morrow, 1992).

There are certain terms that are crucial to understand for explaining the activity base accounting such as activity, resource, resource consumption cost driver and activity consumption cost driver.

Activity

It is a specific action or task required to get the work done. The activity may be a single action or aggregation of many actions. For example, transporting goods from point A to point B ...