Cost Allocation in Small Businesses - Research Paper Example

? COST ALLOCATION IN SMALL BUSINESSES goes here] [Your goes here] [Your college Cost Allocation in Small Businesses Cost allocation is basically a process in which costs of services are identified and assigned to operate any particular business activity. An important point regarding cost allocation is that it is more concerned with the allocation of costs to the right department or unit of an organization instead of being concerned about the actual cost that may incur. It is due to this reason that cost allocation is viewed as a process that helps managers in tracking the actual costs or expenses related to all ongoing operations efficiently and successfully (Tatum, n.d.). Cost allocation through a proper accounting system is considered an important task in every small business. The process of cost allocation needs a company to allocate costs in such a way that cost covers all business components properly. Costs can be allocated does not cover any single aspect of a business, rather it covers multiple areas which incur some expenses. Cost allocation has a number of considerable benefits for small businesses. Let us discuss some of those benefits in order to understand the worth of this process. Awareness of Expenses One of the main benefits that companies get through proper cost allocation is awareness of expenses. Accurate assignment of costs to business processes makes it possible for the managers to know exactly the types of expenses incurred in any particular business operation. Here, it needs to be mentioned that such information is not just critical for the development of operating budgets; rather it is also imperative in the calculation of taxes payable to state, local, and federal tax agencies. The way a company assigns costs to different business units have a profound impact on the amount of taxes that the company pays (Tatum, n.d.). Tool for Planning Another benefit of cost allocation is that it helps companies in doing effective planning for keeping things within budget. Managers of small businesses can make a good use of available resources by using cost allocation process as a way of providing quality services. In businesses, using cost allocation, managers can know what amount they should spend in any particular business process. Cost allocation, as a planning tool, not only helps small companies but also helps people in managing their personal household budget. “As a means of identifying and properly assigning costs, this approach to allocation helps to provide focus and structure to financial planning in a way that would be extremely difficult otherwise” (Tatum, n.d., p. 1). Accurate Cost Estimation Small businesses can also use cost allocation as a tool to know which items associated with any particular department had the most or least impact on the cost generation by that department. For example, if the accounting, marketing, and customer services departments make use of the same printer for producing prints, the company can easily spread the cost out of that printer on all associated departments according to their respective usage of the system. Such an accuracy of cost information results in improving the decision-making mechanisms of a company, as well as helps in enhancing the overall quality of business processes (Grace, n.d.). Enhances Resource Usage Cost allocation also results in enhancing the resource usage. Companies allocating costs to different business departments know that the benefits that they will get will definitely supersede the associated costs. To be specific, when a company has to decide whether it should use the resources of any particular business department, it first takes into account the variable and fixed costs of the department. Though cost allocation, a company is able to know the extent the resources can be used without affecting the associated costs. Determines Expenses Accurately Using cost allocation, a company can determine the costs associated with hiring, retaining, and shifting of employees from one department to another. For example, is an employee is shifted to work for some department other than his/her own department for a day, the costs of that department will determine the expense of adding another employee in the department. Managers can deduct the average daily expenses of the department from the expenses of the day with an added employee to get the actual costs associated with the employee shifted to another department. Cost Allocation Methods for Small Businesses Having discussed the impact of cost allocation on small businesses, let us also discuss some commonly used methods of cost allocation in order to determine which method suits the most to small businesses. Step-Down Method In this method, a support department is chosen by the managers for allocation of its costs among other departments. After doing this, managers choose the next support department for cost allocation. They also include the costs allocated to the previous department, as well as to the other remaining units/departments (Merritt, 2010). Absorption Costing Method Under this method, managers of small businesses allocate fixed costs to products based on the number of sales. For example, for the sale of 50 percent of the manufactured products, 50 percent of the fixed cost will be assigned to the cost of production (Johnston, n.d.). Variable Costs Using this cost allocation method, managers create a list of all variable costs that the company may incur in the production of products. Variable costs generally include shipping expenses, supplies, raw materials, direct labor, and production bonuses (Johnston, n.d.). The amount of these costs can increase or decrease depending upon the amount of production so they are included as part of the product costs. Fixed Costs Using this method, managers list all fixed costs and allocate costs to concerned departments in accordance with those costs. Some of those costs include insurance, rent, property taxes, salaries, and assets’ depreciation. Direct Method In direct-cost allocation, all direct costs involved in the production of any particular product are added together (Tyson & Schell, 2008, p. 192). This is one of the most commonly used cost allocation methods around the world. Using this method, cost of a support department is allocated to the production departments based on the criteria set by the management. These were some of the main cost allocation methods being widely used by small businesses all over the world. The only thing such companies need is perfection in the estimation of costs in order to be able to reap maximum benefits of cost allocation. References Grace, N. (n.d.). Reasons to Allocate Costs. Retrieved from http://smallbusiness.chron.com/reasons-allocate-costs-33821.html Johnston, K. (n.d.). What Method Can I Use to Allocate Overhead Costs to a Product Other Than Direct labor?. Retrieved from http://smallbusiness.chron.com/method-can-use-allocate-overhead-costs-product-other-direct-labor-36786.html Merritt, C. (2010). The Advantages of the Direct Method of Cost Allocation. Retrieved from http://yourbusiness.azcentral.com/advantages-direct-method-cost-allocation-24686.html Tatum, M. (n.d.). What Is Cost Allocation?. Retrieved from http://www.wisegeek.com/what-is-cost-allocation.htm Tyson, E., & Schell, J. (2008). Small Business For Dummies (3rd ed.). Hoboken, NJ: Wiley Publishing, Inc. Read More