Accounting in management is a method, which helps in preparing management accounts and reports that supply timely and accurate statistical and financial data to the managers. Advanced management accounting helps the manager in making long term and short-term decisions related to business. This management helps in measuring, identifying, communicating and interpreting the information or data, which enables a business entity to achieve its goal.
The general principles to allocate the indirect cost to objects of cost are:
This principle based on traditional approach, proportional allocation of indirect cost assigns indirect cost percentage to all or various divisions within the business. This principle helps in determining the percentage every month for all the indirect cost. Sometimes, this is also reviewed or assigned annually. According to Locke et al. (2016), an amount charged in each division within the business depends on indirect cost type.
Cost allocation based on activity:
This principle based on activity-based costing, involves allocating the cost that is more time talking but on the other hand, it shows more accuracy to allocate indirect cost. This principle, firstly need the manager to record and identify each activity of the business division or department within the business. This activity is then considered as the indirect cost. At the last of the period of reporting like the end of the month, the records are analyzed and reviewed, the rate of indirect cost is calculated and proper allocation of indirect cost is done.
Calculating the rate of cost:
The rate of indirect cost is calculated based on both traditional and ABC approaches by dividing the cost that is indirect by the cost object. The examples of such cost objects include square footage or sales revenue. The rate of indirect cost for proper allocation is calculated by using calculations related to overhead cost by cost that is direct which each division of the business incurs.
The cost of the system of the traditional cost is allocating the overhead of the factory to the goods based on resources of production-consumed volume. Under this system, overhead is generally applied upon the hours consumed on direct labor amount or hour of machine used.
The benefits of the system of traditional cost are:
The system of the traditional cost is easily applied. The managers feel easy in tracing all the cost, which is direct and is related to the goods, including the cost of direct materials and labor. In this system of traditional cost, the hours of the direct labor are an easy way for apportioning the cost of overhead.
The system of traditional cost can provide a proper idea of the manufacturing cost of the product or goods. The other benefits of the system of the traditional costing include recognizing the fixed cost importance in the process of production. This system of the traditional costing also provides benefit soaking up the costing up when the production of the goods remains unchanged but the revenue, which is gross, fluctuates or changes. Inland Revenue accepts this system of traditional costing. This system of traditional costing is used in preparing financial histories.
According to Chiarini et al. (2015), the costing based on activity is used in assisting the cost of overhead to cost of the goods or product. The first step in allocating the overhead cost requires identifying the activities, which are costly for completing the product. This costing system is a process, which consumes the resources of overhead. The aim of this system of costing understands all activities needed for making the product of an organisation. This is done by meeting and interviewing personnel within the organisation. The companies or organisations that use the costing based on activity like IBM and Hewlett Packard may assist in identifying the activities needed in making the company product.
The second step in allocating the overhead cost needs assigning the cost of overhead to identified activities in the first step: This step needs that the cost of overhead related to every activity is assigned to all the activity. The third step in allocating the overhead cost is identifying the driver of cost for every activity. This needs the collection of information or data and interviewing the essential personnel in different areas of the company like production, purchasing and accounting. The fourth step is calculating the rate of overhead, which is predetermined for every activity of the business. This calculation is done by dividing the estimated cost of overhead by the level of estimated activity of driver of cost. The fifth step or the last step is allocating the cost of overhead to the products which is done by multiplying the rate of overhead that is predetermined for every activity by activity of cost driver level used by goods or product.
The benefits of Activity-based costing approach are:
More information that is accurate is of cost leading to make better decisions
The information of cost provided by the ABC approach is more accurate as compared to the information of cost supplied by the system of traditional costing. This assists the management of the organisation in making decisions, which are better in areas like pricing of the product, changes in product line, and decisions related to product mix.
Increases the knowledge of the activity of production, which leads in the improvement of process and cost reduction:
ABC approach needs identification of the activities included in the process of producing and assigning costs to the production activities. This approach gives better sight of the included activities and cost of every activity. The company's managers are focused on improving the business efficiency in most of the activities that are costly, hence, assisting in cost reduction.
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