Question

Describe the two stages of activity based costing

Answer 1

Answer:

Activity-Based Costing:

Activity-based costing is a more nuanced approach to allocating overhead. Instead of using a single factor, activity-based costing uses several factors to determine how to allocate overhead. Each factor is tied directly to an aspect of overhead. Then each product is evaluated based on how much of each element of overhead is used to produce the good, and the price is adjusted accordingly.

Stage 1: Allocation to Activities

The first step in Activity-Based Costing is to divide the expenses of certain overhead activities to a per-event cost. For example, say that the overall cost of resetting a machine for production during the year was $1 million. You have two products and you had to switch the machine over 100 times. The first stage of allocation would stipulate that the cost of one setting switch is $10,000.

Stage 2: Allocation to Production

The second step in activity-based costing is to allocate the activity cost to each product. Using the same example, a uniform batch of each product would be produced after every switch. So after every switch, 1,000 units of Product A or 10,000 units of Product B would be produced. The “switching cost” allocated to a single item of Product A would be $10, while the switching cost for a single item of Product B would be $1.