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Allocation of Fixed Costs

Part I: Activity Based Management and Activity Based Costing (ABC) Benefits in an Organization

The main differentiation point that makes ABC unique from other allocation methods is its focus on minimization of waste and idle capacity in the production processes. Activities within the production process to which indirect costs can directly be attributed to production are identified for estimations and allocation. The entire activity costing enables the management to single out cost element on each product using activity costing product costing computation. This is a purely accounting technique from which management decision making insights can be developed. Decision making from such information is the specialty of activity based management which highly depends on cost accounting to make managerial decisions based on the cost benefit analysis (Edwards, Hermanson and Invacevich 2007). It is basically a two faced process which involves tracing cost from production processes and departments during the initial stages. The next stage involves translating the activity costs to the individual products so as to ascertain the actual cost element borne by every production unit depending on the reliance it has on particular activities. The fundamental difference is therefore in the fact that the other models pay lesser interest to cost accounting and allocation in order to determine the most profitable production option.

The types of companies that are best suited by these philosophical approaches of management are production companies which preferably have several production departments with more than one product. It is important to note that these products under the same production line are likely to be similar or closely related such as one product being work in progress for another product or maybe a byproduct with some cash value in production. In such a production system, the operations are integrated in order for the management to monitor and follow performance alternatives which are more beneficial for consideration.

Allocation of Fixed Costs

HP Compaq is an example of a company that implements the ABC approach. This is a manufacturing company which has different production aspects for the main finished product which is principally a computer. According to Edwards, Hermanson and Invacevich (2007, p50), the company was capable of streamlining its operations in reducing costs and improve quality using just the internal accounting systems when ABC was implemented.

Part II: Efficiency Improvement and Cost Reduction Concepts

         Concept Description Implementation Benefits
         Value Chain


Incorporation of value adding processes by streamlining production by focusing from handling of raw materials to delivery of finished products to customers (Martin, n,d). i) production improvement
ii) quality customer services
iii) eliminates delays and backlogs
iv) eliminates wastage and excess
v) internal competition


Performing production operations as and when needed to eliminate wastage and excess (Martin, n,d). i) reduces costs
ii) improved product quality
iii) little inventory buffers
iv) flexible production
v) stopping production to correct defects
vi) elimination of waste and excesses
vii) improved customer service
Theory of Constraints Proposes that every organization has production limitations which must be overcome by managing resources efficiently; maximize throughput and minimize inventory and operating expense (Martin, n,d). i) cost reduction
ii) wastage reduction
iii) improved efficiency
iv) increased productivity
  • Edwards, J. D., Hermanson, R. H. & Invacevich, S. D. (2007) “Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73,” Retrieved from: https://docs.globaltext.terry.uga.edu:8095/anonymous/webdav/Accounting%20Principles/Accounting%20Principles%20Vol.%202.pdf
  • Martin, J. R. (n.d.) “Management Accounting: Concepts, Techniques, and Controversial Issues – Chapter 8: Introduction. Management And Accounting Web Home Page,” Retrieved from: https://maaw.info/Chapter8.htm

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