ABC costing assigns\ncosts to each activity of the production process. It is an accounting method used\nfor calculating the total cost incurred in the manufacture of a product. This\nprocess is a more accurate one as it covers not just the direct costs of production\nbut also the indirect ones such as overhead, etc. <\/p>\n\n\n\n
Activity based costing is an accounting method meant for assigning overhead and indirect costs to related products and services. Moreover, activity based costing is the process of assigning indirect costs in the form of salaries and utilities to different products and services.<\/p>\n\n\n\n
Activity based costing for companies is all about devising the appropriate pricing strategy for identifying product costing, product line profitability analysis, target costing and service pricing strategies. To add to this, such costing strategy also increases the reliability of cost data. <\/p>\n\n\n\n
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What are Some of Best Activity Based Costing Examples<\/strong><\/p>\n\n\n Example 1:<\/strong>\nHow to calculate the cost of each activityin a production process?<\/p>\n\n\n\n As\nmentioned earlier, activity based costing calculates costof each activity that\nis involved in the production of goods and services. For instance, XYZ company\nwants to calculate machine-set up costs as well the costs involved in\ninspection activities. It has the following information (given in the table)\navailable:<\/p>\n\n\n\n Using\nthe ABC costing method, both machine-set up costs and inspection costs can be\ncalculated by dividing cost pool total with cost driver. XYZ company would use\nthe following formula:<\/p>\n\n\n\n Example 2:<\/strong>\nHow to calculate overhead rate for each activity?<\/p>\n\n\n\n In\nthe table given here, have been mentioned these two activities- cost pool and\ncost driver. <\/p>\n\n\n\n Using\nthe ABC Costing method, overhead rate for each activity can be calculated by\ndividing cost pool with cost driver.<\/p>\n\n\n\n XYZ\ncompany would use the following formula from ABC costing:<\/p>\n\n\n\n 120,000\/200=\n600<\/p>\n\n\n\n 80,000\/1600=\n50<\/p>\n\n\n\n Overhead\nrate for machine maintenance and overhead rate for production steps would also be\ncalculated in a similar way. <\/p>\n\n\n\n ABC costing\nis an accounting method used for calculating the total costs involved in the\ncreation or manufacturing of a product. Activity based costing refines the\ncosting system for measuring non-uniformity in the use of resources of an\norganisation. The key benefits of activity based costing are:<\/p>\n\n\n\n Activity\nbased management develops bases for assigning overhead costs to products.\nUnlike traditional methods that assigned costs based on machine hours or direct\nlabour costs, activity based costing assigns it according to activities, which\nare able to generate costs. <\/p>\n\n\n\n Activity\nbased costing makes the nature of different indirect costs including\ndepreciation, utilities and salaries traceable. It also helps raise the unit\ncost of low volume products. ABC costing further increases the number of cost\npools that are required for assembling overhead costs. <\/p>\n\n\n\n Activity\nbased costing provides a better justification of costs in manufacturing\noverhead. It also helps find out which processes have wasted costs and\ndetermine the profit margin of products with more precision. <\/p>\n\n\n\n ABC\ncosting aside from allocating manufacturing overhead to processes as well as\nproducts also offers realistic costs of manufacturing for specific products. <\/p>\n\n\n\n One\nof the main elements of activity based costing is adding value to cost\nprocesses in such a way that all forms\nof non value based activities get eliminated. The entire management gets benefitted\nfrom this core feature of activity based costing. <\/p>\n\n\n\n Through\nthis costing method, it is also possible to generate statement of expenditure\nthat can further be used for comparing the cost of each activity. With the help\nof such comparison, it is easier to identify the costs that need to be\neliminated and those that need to be improved.<\/p>\n\n\n\n TQM\n(Total Quality Management) and BPR (Business Process Re-engineering) are useful\nfor the management in adapting approaches that improve the financial\nperformance of company in question. The approach leads to quick and easy\ndetermination of transfer pricing, service\/product pricing and cost management.\nIt is for this reason that ABC method of costing has also been defined as a productivity\nimprovement approach. <\/p>\n\n\n\n Explaining Activity Based Costing Steps in Detail<\/strong><\/p>\n\n\n\n Activity based costing methodology assigns indirect costs to products\/services by finding out the cost of each activity involved in the production process. Therefore, this method also assigns costs to products based on consumption. Steps involved in activity based costing are:<\/p>\n\n\n\n Step 1: Grouping production\noverheads into activities<\/strong><\/p>\n\n\n\n When\nwe talk about activities in the context of ABC costing, cost pool is an example\nofone such activity created for identifying and allocating production\noverheads. The words cost pool and activities are thus often used\ninterchangeably. There is a cost driverfor each pool. <\/p>\n\n\n\n Step 2: Identify cost drivers\nfor each activity <\/strong><\/p>\n\n\n\n Cost drivers impact\nthe level of cost. A good example could be quality control wherein one could\nfind out the very cost of quality control by counting the number of inspections\nmade and the total number of units produced. <\/p>\n\n\n\n Step 3: Calculate Overhead Absorption Rate<\/strong><\/p>\n\n\n\n In the next step, OAR\nor Overhead Absorption Rate is calculated for each activity. You can reach OAR by\ndividing activity cost with information about cost driver. Calculating overhead\nrate this way allocates overhead rates to each product and service. <\/p>\n\n\n\n Step 4: Absorb the activity costs into the\nproduct <\/strong><\/p>\n\n\n\n In activity based\ncosting, once the overheads are assigned to activities or grouped into cost\npools, it is mandatory to relate them or absorb those into cost objects\n(products and services). The following example would explain this better. Once\nyou are aware about the total number of inspections made on a product, you can\neasily absorb the corresponding quantity of quality control costs. <\/p>\n\n\n\n Step 5: Calculate profit\/loss\/production cost per\nunit <\/strong><\/p>\n\n\n\n Profit, loss or\nproduction cost per unit could be identified by multiplying cost driver with\nvolume of cost driver units. A good example could be multiplying cost per\npurchase order with the number of orders required per product for a particular\nmonth. This would provide profit, loss or production cost per unit of a\nparticular product for that particular month. <\/p>\n\n\n\n FAQs<\/strong><\/p>\n\n\n ABC management tools are required for calculating cost of production, profitability and production costs. Such calculations are further useful in taking such strategic decisions as outsourcing, pricing and measurement. Aside from the above, this method has following uses: The first difference between the two is that in traditional method cost objects and used up resources are used for evaluating costs whereas activity based costing relies on activities used by cost objects. In order to calculate activity cost, all you need to do is divide total overhead in each cost pool with total cost drivers. This would give the rate of cost driver. Summary<\/strong><\/p>\n\n\n\n Activity based costing allocates overheads by assigning indirect costs to different cost pools. These cost pools are further divided by a cost driver to reach overhead absorption rate. Therefore, organisations, specifically manufacturing units depend on this data or cost set for identifying not just the rate of profit but also determining the sales price. <\/p>\n","protected":false},"excerpt":{"rendered":" Activity based costing is used by businesses and manufacturing units for calculating indirect costs involved in making a product. This costing method is ideal for identifying the cost of each individual activity in the production process for manufacturing a product involves both direct and indirect costs. Identifying such costs is useful in improving profit margins […]<\/p>\n","protected":false},"author":64,"featured_media":15599,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[76],"tags":[7627,7626,7625],"acf":[],"yoast_head":"\n![\"Activity](\"https:\/\/cdn.techjockey.com\/blog\/wp-content\/uploads\/2020\/03\/3-2.png\")
<\/figure><\/div>\n\n\n\n Activity<\/strong>\n <\/td> Budgeted Cost<\/strong> <\/td> Cost Driver<\/strong><\/td> \n Cost<\/strong>\n <\/td><\/tr> Machine Set-up <\/td> \n 2,00,000.00\n <\/td> Number of Machine-Setups<\/td> 340 <\/td><\/tr> Inspection<\/td> \n 1,40,000.00\n <\/td> Inspection Hours<\/td> 7,500 <\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n \n
Cost Pool- Activity<\/strong> <\/td> Estimated Overhead<\/strong><\/td> Cost Driver<\/strong> <\/td> Expected Activity<\/strong><\/td><\/tr> Purchase <\/td> 120,000<\/td> Number of purchase orders<\/td> 200<\/td><\/tr> Production steps <\/td> 202,500<\/td> Number of set-ups <\/td> 250<\/td><\/tr> Assembling <\/td> 80,000<\/td> Assembly hours <\/td> 1600<\/td><\/tr> Machine Maintenance <\/td> 300,000<\/td> Machine hours <\/td> 10000<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n \n
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<\/span>Advantages of Activity Based Costing in Manufacturing Industry<\/span><\/h2>\n\n\n
![\"Traditional](\"https:\/\/cdn.techjockey.com\/blog\/wp-content\/uploads\/2020\/03\/2-2.png\")
<\/figure><\/div>\n\n\n\n
<\/span>Activity Based Management<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>Traceable Nature of Indirect Costs<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>Justification of Overhead Costs<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>Realistic Cost<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>Non-value Based Activities Included<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>Statement of Expenditure<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
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<\/span>TQM and BPR<\/span><\/h3><\/li>\n<\/ul>\n\n\n\n
\n\n\n\nWhat are the uses of activity based costing?<\/h5>
– Increases the reliability of cost data
– Produces almost true costs
– Classifies the costs incurred during production <\/p>What's the difference between traditional costing and activity based costing?<\/h5>
Second, traditional costing adds average overhead rate to the direct costs of products. The overhead rate is applied on the basis of cost driver such as number of labor hours required for making a product. Activity based costing, on the other hand, identifies overhead rate of each product or activity.
Third, in traditional costing it is the company or organisation that determines the cost of production whereas within activity based management costs are determined as per customer feedback and pocket range.
Fourth, traditional costing depends upon a single overhead pool. However one of the main elements of activity based costing is taking into account identifiable product parts or labor.<\/p>How to calculate activity cost?<\/h5>
To finally achieve activity costs, compute the number of hours\/parts\/units etc. used by the activity and multiply the same with the cost driver rate.<\/p><\/ul><\/div>\n\n\n