Managerial Accounting
Why do you think the division was profitable immediately under the new ownership?
An organization uses cost allocation methods to determine the cost of one unit of its product. Cost allocation refers to the process of linking all the cost incurred during the production process to the product. Direct costs and indirect costs are the cost associated with production of a product. Direct costs are those that are traceable to the product such as the price of wool in the production of shirts. Indirect costs are not traceable to the final product directly as taxes charged. Cost allocation enables the organization to determine the cost of its products by ensuring that a profit margin allocated to every unit produced.
In the case study, the manufacturer found that a component of the company was producing losses thus decided to sell. A group of workers bought the division and realized profit immediately after the sale. This change in profitability means the cost allocation method used by the organization did not cover the expenses. The use of traditional methods...
The method uses many estimates thus prone to inaccurate determination of product overhead. The use of traditional costing methods results to under or over costing of products (Vanderbeck, 2012).
The workers who bought the division were aware of all the processes involved in the division thus could determine the cost to the product accurately. The workers adopted activity-based costing for the products, which assumes that the cause of costs is activity and activities are determined by cost objects. Activity-based costing provides an accurate way of determining the indirect costs associated with the product. Unlike traditional costing methods used by the previous management, under costing is avoided thus the immediate impact on the profitability of the organization. The use of activity-based costing is expensive to implement but improves cost allocation.
B. What kind of cost allocation method may have caused the sale of a profitable division, and can you suggest a better method of cost…
