Question

Distinguish between arbitrary and cause-and-effect allocations.

Answer 1

Traditional costing is a classic example of arbitrary cost allocation because they allocate the overheads on the basis of either labor hours or machine hours. This is not logical and it does not follow any scientific basis of allocation.

Cause and effect allocation is an approach where overheads are allocated on the basis of determinants of cost. For example, in ABC costing, the overhead cost is allocated on the basis of activity consumption. There is more than one determinant as compared to only one determinant under Traditional costing.

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