Question

Although alternative approaches of cost assignment are available their usefulness is limited due to different and perhaps unrealistic assumptions. Hence the choice of cost assignment method needs careful attention. Discuss

Answer 1

The traditional approach to cost allocation is usually based on pre determined overhead rate that is based on machine hours or direct labor hours. However, modern cost allocations techniques have evolved over time that include activity based costing which allocates cost on the basis of cost pools, job order costing that allocated costs specific to an identifiable job among others. Although the modern techniques are quite insightful and more realistic the use has been limited majorly owing to ease of use, cumbersome process, multiple calculations, requirement of higher skills and unrealistic assumptions. The choice of cost allocation method is crucial since any under absorbed or over absorbed overheads is determined on the same basis. If the entity has fewer overheads then the traditional allocation will be a better choice to allocate and analyse the variances. Similarly, if the overheads are too many and can be divided in to multiple activities or stages, then activity based costing can be adopted. But care must be exercised while dividing the activities and the allocation base for each activity which requires detailed attention and understanding of the process. If the job involves working for a specific client or product then job order costing is more suitable.