Activity based costing
1 Introduction
The traditional method of dealing with overheads is to split them between variable overheads and fixed overheads. If we are using absorption costing we then decide on a suitable basis for absorption (e.g. labour hours) and absorb the overheads on that basis.
Activity Based Costing (ABC) attempts to absorb overheads in a more accurate (and therefore more useful) way.
2 The steps to be followed are as follows:
identify the major activities that give rise to overheads (e.g. machining; despatching of orders)
determine what causes the cost of each activity – the cost driver (e.g. machine hours; number of despatch orders)
calculate the total cost for each activity – the cost pool (e.g. total machining costs; total costs of despatch department)
calculate an absorption rate for each cost driver
calculate the total overhead cost for each product manufactured
calculate the overhead cost per unit for each product
Una manufactures three products: A, B, and C.
Data for the period just ended is as follows:
A | B | C | |||
Production (units) | 20,000 | 25,000 | 2,000 | ||
Sales price ( per unit) | $20 | $20 | $20 | ||
Material cost (per unit) | $5 | $10 | $10 | ||
Labour hours (per unit) | 2 hours | 1 hour | 1 hour |
(Labour is paid at the rate of $5 per hour)
Overheads for the period were as follows:
Set-up costs | 90,000 |
Receiving | 30,000 |
Despatch | 15,000 |
Machining | 55,000 |
190,000 |
Cost driver data:
A | B | C | |
Machine hours per unit | 2 | 2 | 2 |
Number of set-ups | 10 | 13 | 2 |
Number of deliveries received | 10 | 10 | 2 |
Number of orders despatched | 20 | 20 | 20 |
Calculate the cost (and hence profit) per unit, absorbing all the overheads on the basis of labour hours.
Calculate the cost (and hence profit) per unit absorbing the overheads using an Activity Based Costing approach.
| A | B | C | D | E | F | |
|---|---|---|---|---|---|---|
| 1 | Total overheads | 190000 | ||||
| 2 | Total labour hours | |||||
| 3 | A | 20000 | × 2 = | 40000 | ||
| 4 | B | 25000 | × 1 = | 25000 | ||
| 5 | C | 2000 | × 1 = | 2000 | ||
| 6 | 67000 | hours |
3 Advantages of, and problems with, activity based costing.
Activity-based costing
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