Allocation of Fixed Costs - Essay Example

But in recent environment where the overheads such as IT cost became a major portion in product cost. In advanced manufacturing technology overheads are likely to be more important and therefore it is difficult to justify the IT costs on the basis of absorption costing methodology. The problem arises when the company is not able to decide that on which basis the IT costs should allocate into company products. There are many different techniques can be used for allocation of IT costs. Some of them are mentioned below According to many successful financial advisors, the use of Activity Based Costing (ABC) methodology can be a best and beneficial technique for the allocation of IT costs.

In addition, it is also proved by accounting practices of past few decades that activity based costing is absolutely a best technique for charging allocating the major complex overheads costs like IT costs. Activity based costing is just one method of charging IT costs because it focuses on the identification of actual IT costs and can give the true and accurate results. A simple charge back costing technique can be also a good option for allocation of IT cost but it is only feasible only at first stage and the company can face many of big inherent problems at the end of process.

Why Activity Based Costing (ABC) is best technique for the allocation of IT costs ABC Vs Flat Rate: In comparison with other costing methodologies the Activity based costing technique always gives accurate results and could be a true measure of profitability. For example, Allocation of overheads on flat rate system hides the inefficiencies of the systems and causes many serious problems in long run. Using a flat rate is can be the best option to get cost transparency but sometimes it can be headache for business leaders because they started to thin k that, they are charged greater than the their use.

Using flat rate system, there is a possibility of greater charges in respect with little use of service. Complexity of IT costs: On the other side of coin, other traditional approaches are not able to measure the complexity of the IT costs properly while the Activity based costing recognize the complexity with its multiple cost drivers. Realistic Approach: In modern competitive environment, companies must be able to assess profitability realistically. Activity based costing methodology facilitates a good understanding of what drives IT costs.

Purpose of Allocation Simple the cost allocation is the process of charging the indirect costs in to products on the base of services they consume. It is a process of charging the portion of shared services from cost centers in to a product or service. In current technological environment, the overheads are likely to be far more important and in fact direct labour may account for as little 5% of a product cost. In advance environment many non-volume related support activities such as IT costs have captured a great part in company’s profitability that’s why the fair allocation of IT costs is more important to measure the true profitability level.

Benefits of Allocation There are many benefits of allocation of IT costs. Some of them are mentioned below: Proper Accountability of resources: In current competitive trends, enterprises demand more accountability of their funds and they try to use their resources in effective manner. For this purpose, Proper allocation of IT