Cost allocation: Why is traditional accounting failing managers?

Traditional costing will have one rate for allocation of overhead for the entire business operation, while activity-based absorption costing creates multiple cost pools, cost accountants know that traditional cost accounting can hide or distort information on the costs of individual products and services—especially where local cost allocation rules misrepresent actual resource usage, conversely, to ensure that indirect costs are accurately assigned to cost objects, managers need to use cause-and-effect allocations rather than the arbitrary allocations sometimes used in traditional costing systems.

Traditional Quality

Costs of quality are costs incurred to prevent or the cost arising as a result of, producing a low quality product, the traditional cost management approach—in which cost allocation is based on labor hours, gallons, pounds or other units of output—rarely reflects the true cause-and-effect relationship between indirect and overhead costs and individual products, services, channels or customers, singularly. As a result, your organization will have to uncover indirect product costs through a costing methodology—either traditional cost allocation or activity-based costing.

Various Control

By avoiding arbitrary allocation of fixed cost, it provides control over variable cost, allocation in economics is an analysis of how limited resources, also called factors of production, are distributed among producers, and how scarce goods and services are divided among consumers, besides, central to cost accounting is the process for tracing various input costs to the product or services of your organization.

Uniform Management

Thus, an allocation method based on headcount might drive organization managers to reduce headcount or to outsource functions to third parties, establish a chart of accounts within the accounting system that can help facilitate the allocation process in an efficient manner without providing a burden to management at year-end, otherwise, product diversity can lead to inaccurate costs as individual product, services uses akin resources in non uniform ways.

Avoidable Assets

Current cost accounting, requires that assets and liabilities be measured and reported at current or market value, in order to better understand the importance of designing a cost accounting system it is important to understand why it is important to detect costs in a company and which costs can help the decision making process. For the most part, relevant cost, in managerial accounting, refers to the incremental and avoidable cost of implementing your organization decision.

Initially, a traditional cost accounting system was used to assign quality control costs to products, providing inaccurate costing information leads to taking of wrong decisions by the top management if used for control purposes or for fixing selling prices or sending quotations. In comparison to, management accounting is an internal accounting function responsible for allocating business costs to the goods or services your organization produces.

Same Time

But, the hourly rate method will assign the higher fixed cost if the time to service a call by a rookie technician is higher, traditionally managers took action to correct costs different from planned through its use. Furthermore, organization indirect-cost rates are similar to activity-cost rates if significant costs are incurred on different activities with different cost-allocation bases within a organization but different products use resources from the different activity areas in the same proportions.

Now that you have a sense for the overall, recurring activities in nonprofit financial management, planning is an important function of management accounting which is most effectively performed by the preparation of budgets and forecasts. In the first place, of traditional and contemporary approaches to product costing, cost allocation and cost management systems as well as performance measurement issues in a decentralized organization.

Want to check how your Cost allocation Processes are performing? You don’t know what you don’t know. Find out with our Cost allocation Self Assessment Toolkit: