Activity based costing in manufacturing

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Activity based costing in manufacturing

Activity-based costing is more refined approach to costing products and services than the traditional costing method.

Activity based costing in manufacturing

It involves the following steps: Identification of activities involved in the production process; Classification of each activity according to the cost hierarchy i.

Cost Hierarchy The first step in activity-based costing involves identifying activities and classifying them according to the cost hierarchy.

Manufacturing

Cost hierarchy is a framework that classifies activities based the ease at which they are traceable to a product. The levels are a unit level, b batch level, c product level, and d facility level.

Unit level activities are activities that are performed on each unit of product. Batch level activities are activities that are performed whenever a batch of the product is produced. Product level activities are activities that are carried out separately for each product.

BREAKING DOWN 'Activity-Based Costing (ABC)'

Facility level activities are activities that are carried out at the plant level. The unit-level activities are most easily traceable to products while facility-level activities are least traceable.

Example Alex Erwin started Interwood, a niche furniture brand, 10 years ago.

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He ran the business as a sole proprietorship. While he has 50 skilled carpenters and 5 salesmen on his payroll, he has been taking care of the accounting by himself. Alex applied traditional costing method during all of the 10 years period, and based the pre-determined overhead rate on total labor hours.

Interwood's sofa range includes the 2-set, 3-set and 6-set options. Platinum Interiors recently placed an order for units of the 6-set type. The order is expected to be delivered in 1 month time. You are not a fan of traditional product costing system.

You believe that the benefits of activity-based costing system exceeds its costs, so you sat down with Aaron Mason, the chief engineer, to identify the activities which the firm undertakes in its sofa division.

Next, you calculated the total cost that goes into each activity, identified the cost driver that is most relevant to each activity and calculated the activity rate.

The results are summarized below:Note that the total overhead for current year is $2,, using activity-based costing, just as it was using a traditional costing method.

The total amount of overhead should be the same whether using activity-based costing or traditional methods of cost allocation to products. Activity-based costing attempts to overcome the perceived deficiencies in traditional costing methods by more closely aligning activities with products. This requires abandoning the traditional division between product and period costs, instead seeking to find a more .

Activity-based costing is an approach that allocates fixed overhead and administrative costs to activities, which are cost-incurring events. Activity-based costing assigns costs to those factors and activities that have a direct cause and effect relationship with a particular overhead cost.

Activity-based costing is an approach that allocates fixed overhead and administrative costs to activities, which are cost-incurring events.

Activity based costing in manufacturing

Activity-based costing assigns costs to those factors and activities that have a direct cause and effect relationship with a particular overhead cost. Activity-based costing systems allow manufacturing companies to more accurately allocate overhead expenses to specific products, as multiple cost drivers are used.

Activity Based Costing is a method of allocating production overheads to products manufactured in such a way that is more equitable than the traditional method of using a single allocation base, such as labour hours or machine hours.

Activity-Based Costing (ABC)