activity based costing

(d) It helps in eliminating non-value added activities thereby reducing the per unit cost of product. Based on example cost pools already identify, but in real life, we need to define base on the actual situation. Platinum Interiors recently placed an order for 150 units of the 6-set type.

activity based costing

Activities can be perceived as consumers of resources in production of materials, services, events, or information. Ac­tivities are the common denominator between business process improvement and informa­tion improvement. Now, since you have all the data needed, calculate the order cost using activity-based costing.

Activity Based Costing – Main Advantages

Duration drivers establish an average hourly rate of performing an activity while intensity drivers involve direct charging based on the actual activity resources relevant to a product. Generally, the products are cost objects, but the customers, services or locations can also be the cost objects. Use existing accounting and financial data, which includes labour and capital equipment expenses and any other resource that can be changed or eliminated. Some reports to analyse include budget, general ledger, supplier invoices. (b) It charges overhead cost to product according to activities involved in the product instead of using average overhead distribution rate as in case of traditional method. This type of costing aims at tracing as many as costs as possible to be subsequently accounted as direct costs.

activity based costing

(e) Non-financial information regarding quality flexibility and value to the customer can be received. For example, PCB Ltd. is manufacturing circuit board for computer monitor, TV and aeroplane. However, the circuit board for the aeroplane is tested for a longer time by highly paid technicians because it must be 100% error-free. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.

Step 8. Act on the Information

Similarly, a customer may be identified as a low value customer because of loss from transactions with him according to strategic ABM. Managers can set cost reduction targets in terms of reducing the cost per unit in relation to cost allocation base in different activities areas. For instance, a manager may aim at reducing cost of transporting the product from Rs. 5 per unit to Rs. 4.50 per unit. Refer to drivers which directly charge for the resources used each time as activity is performed.

activity based costing

When you divide the total overhead in a cost pool by your total cost drivers, you get a cost driver rate. But, some production-related activities use more overhead expenses than others. As a result, traditional costing can give an inaccurate cost of making each product.

Difference between Traditional Costing and ABC Approach

These (production) departmental overhead expenses are finally assigned, or charged, to products on a suitable basis. The factors which influence the cost of Law Firm Accounting & Bookkeeping Service Reviews a particular activity should identified, which are known as Cost Drivers. ABC is based on the assumption that cost behavior is influenced by cost drivers.

  • Your employees might miscalculate or even exaggerate their time spent working on an activity.
  • The ABC aims to identify the activities which results in currency of the cost.
  • In Table 1 in the spreadsheet above, we are given the budgeted marginal cost for two products.
  • PeopleSoft stands out for its comprehensive approach to financial management and cost analysis.
  • Moreover, Activity-Based Costing (ABC) has been developed as a more modern absorption costing method to overcome the problems of under-costing and over-costing and to produce more accurate product costs.