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Cost allocation

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Why is cost allocation such a major issue that multiple accounting methods exist? Why isn't it more straightforward? Explain in detail an approach that you believe is generalizable to numerous contexts.

Cost Allocation--From the Simple to the Sublime. Management Accounting Quarterly. Fall 2002. Available online @ http://www.imanet.org/pdf/1239.pdf

Cost Allocation and Activity-Based Costing Systems. Available online @ http://www.pearsoned.ca/highered/divisions/virtual_tours/horngren/man_acc/Ch05ManAcc.pdf

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Solution Summary

Your response is 627 words and includes a discussion of variable costs, non-shared fixed costs, and shared fixed costs and potentially allocation ideas for each of these. The discussion talks about three important reasons to allocate and why they matter.

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Why is cost allocation such a major issue that multiple accounting methods exist?

Cost allocation is a big issue because it impacts how firms price their goods, what products they choose to sell, and how managers are rewarded. In order to discover the full cost of products, segments, and customer groups, firms allocate shared costs to division and jobs. This permits them to be sure that they are pricing to cover all costs, not just direct ones incurred by just one product or one segment of the business.

After allocation, firms can then "see" whether the market price affords them an adequate mark up and therefore make plans to make and sell a particular product. If too much is allocated, or the allocation doesn't reflect the true use of resources by the various areas, the product might "look" unprofitable and therefore the plans might be scrapped. Conversely, a product that is really using a lot of shared resources but isn't given a large allocation, might look great but really be a ...

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Carol Sargent, PhD
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  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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