Activity Based Costing

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In a highly competitive environment that characterizes the world today companies are forced to come up with innovative ways for reducing production costs while at the same time not compromising on quality . It is for this reason that there has been a shift from the traditional costing methods to those that provide more useful information on costs profitability of products and customers like activity based costing

Definition

Activity based costing is a departure from the traditional costing methods . ABC is a costing

method developed to solve the problems presented by the traditional techniques . It allocates overheads to products based on the activities that are involved in the production

Traditional costing methods resulted in accurate cost measurements thereby leading to wrong management decisions . ABC overcomes this by allocating the overheads to activities

How it works

ABC starts by establishing the cost pools or activity centers . Overheads are then allocated to these cost pools . The cost pools can be materials ing , machine set up , engineering etc

The identification of the activities that are undertaken during the production process is done . These activities are called cost drivers Examples of cost drivers are number of deliveries , number of production s , number of machine set ups etc

The next step is the allocation of the overheads in the cost pools to the cost drivers to arrive at the rate per cost drivers . Lastly the rate per cost driver is then divided by the number of units produced to get the cost unit . The all the cost units (O Guin Pg .32

Activity Based Costing helps the employees to establish and know the costs involved in the production process . This understanding helps them analyze and identify the cost drivers that add no value to the production process . This process then helps in the implementation of the continuous process with the aim of achieving cost efficiency better characterized by Kaizen Costing

Activity based costing can also be further expounded by the following brief example

Consider company X with the following

Products A B

Production (units ) 5000 2000

Raw materials usage (units ) 5 2

Direct materials cost ) 10 5

Machine 0 .5 0 .5

Number of receipts 10 10

Number of production 3 2

Continued after chart below

Activity Based Costing can be clearly demonstrated by the following chart

People , materials , miners

Facilities , machines etc

How much resources and

Activity requires Processes : felling

Poaching , assembling

How much an object utilizes

An activity

Products , services

Customers , markets

Channels etc

Continuation from above

Overhead

Set up 10 ,000

Receiving 5000

Machines 10 ,000

The first step is allocating the overheads to cost drive

Set up 10 ,000 2000

Receiving 5000 250

Machines 10 ,000 2 .857

3500

Then , the calculation of cost per unit

Products A B

Set up 6000 1 .2 4000 2

2000

Receiving 2500 0 .5 2500 1 .25

2000

Machines 0 .5 2 .857 1 .4285 0 .5 2 .857 1 .4285 Products A B

Direct materials 5 2

Set up...