Cost allocation and activity based costing Essay

Cost allocation and activity based costing - Essay Example Cost allocation is a concept that refers to the determination of the expenses incurred to offer a service. Costs can be allocated as direct, indirect and incremental costs. In the production process, manufacturers should be able to determine what costs fall under direct, indirect and incremental, in order to facilitate the ascertainment of cost of production. Activity based Costing is a concept that refers to the ascertainment of various activities involved in the production of goods and services. Thereafter, the overhead costs are allocated to each activity and then assigned to the products and services. Traditional costing on the other hand, allocates overhead costs using predetermined rate. That is, there is no allocation of costs on activities prior to the products and services. According to Vercio and Shoemaker, the most accurate method of cost allocation is Activity-Based. Unlike traditional costing method, Activity Based Costing recognizes the fact that, during a production pr ocess, not all costs are attributed to the volume of products and services produced. Therefore, Activity Based Costing determines the cost drivers associated with the customers, batches, products and administration related costs directly connected to the units produced. In order to ensure accuracy in cost measurements to facilitate informed decision-making during the production process, the costs that are not related to unit production should be secluded. In batch processing, the fundamental idea is to reduce the cost of production.