Activity Based Cost Allocation

Activity Based Cost Allocation

See Also:
Implementing Activity Based Costing

Activity Based Cost Allocation

Let’s dig into activity based cost allocation. But first, we need to note that not all the allocation methods are based on the “cause and effect” concept. This is important because CEOs and other managers need to know what the real cost of a product or service is. Once that is known, two other considerations need to be addressed:

Allocating Costs to Maximize Profits

The first question you need to ask is whether or not on any of the products or services have a negative income (after allocated fixed manufacturing costs). If so, the next question if whether or not eliminating/discontinuing those products or services will result in loss of profit. In other words, is any of your client’s other income a result of carrying that product or service? Or is there some other product or service that can replace that income source and increase profitability? If so, then eliminate the product or service so that you can increase the overall profitability.
If the answer is “no,” then you need to take a different approach. This approach involves assigning/allocating costs based on the ability to bear costs or some other equitable method. The goal for these methods is to keep the Board happy; so, the firm does not show any products or services that are losing money.  In addition, these methods need to find another way to maximize profit by incentivizing the sales staff to sell certain products. Accomplish this by allocating overhead in such a way that each sales person’s bonus or commission is tied to the products or services that maximize profit for the firm.

Allocating Overhead

The most common approach used to allocate overhead (and joint costs) equitably is the relative sales value approach. It allocates overhead to products based on overall sales value. This approach works best in situations such as a full service hardware store that offers lumber, equipment and garden supplies. Chances are in a situation of that nature that the garden supply area would either break even or lose money if only based on its “cause and effect” share of overhead. Chances are that that department also contributes to the profitability of the other departments.
As a result, allocating the building overhead based on total revenues of each department would enhance the perceived profitability of the garden supplies department. Thus, your Board would be happy. Your CEO wouldn’t constantly explain that overhead is an allocated fixed cost. All that matters is overall profitability. Over, and over, and over again.
In conclusion, allocating costs can do more than save taxes under full costing. Use this as an additional service you can offer your clients to help them maximize their profits.
activity based cost allocation

ARTICLES YOU MIGHT LIKE

The Struggles of Private Company Accounting

Hiring the right accountant  When I meet a business owner operating at a successful $10 million in revenue, they often mention, “My CPA”… I immediately know that CEO/Entrepreneur is referring to their Tax CPA.  That is because one thing that all Entrepreneurs have in common is that they must file a tax return.  So, from

Read More »

IN CRISIS? GET A STRATEGIC CFO! – CEO Blindspots Podcast

Friend of the firm, Birgit Kamps, recently had Strategic CFO President, Dan Corredor, as a guest on her podcast, CEO Blindspots. CEO BLINDSPOTS HOST: Birgit Kamps. She was speaking five languages by the age of 10, and lived in five countries with her Dutch parents prior to becoming an American citizen. Birgit’s professional experience includes starting

Read More »

SHRM calls ICHRA the 401K for Group Health Benefits

Fed-up with group health insurance? ICHRA is the new way to offer great health benefits and avoid ACA penalties, SHRM calls it the 401K for group health benefits.  In 2020 the Department of Labor, HHS and IRS changed the rules for employer health benefits. They changed the Affordable Care Act mandates and penalties for every

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

SHARE THIS ARTICLE

JOIN THE NEXT STRATEGIC CFO™ SERIES

Strategic CFO™ Financial Leadership Workshop
The Art of the CFO®

Days
Hours
Min
Sec

September 12-15th 2022