Question

• Discuss how to apply activity-based costing to a manufacturer or a service industry. Include the calculation that is necessary.

Answer 1

Meaning:-

• Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services.
• This accounting method of costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products

Application ABC to manufacturing/Service

• Identify all the activities required to create the product.
• Divide the activities into cost pools, which includes all the individual costs related to an activity—such as manufacturing. Calculate the total overhead of each cost pool.

Cost pool Meaning:-Cost pools refers to groups of accounts serving to express the cost of goods and service allocatable within a business or manufacturing organization

• Assign each cost pool activity cost drivers, such as hours or units.
• Calculate the cost driver rate by dividing the total overhead in each cost pool by the total cost drivers.
• Divide the total overhead of each cost pool by the total cost drivers to get the cost driver rate.
• Multiply the cost driver rate by the number of cost drivers.

Example:-

Let’s figure out how much you are spending on utilities to create a product. To do this, you estimate that your total utility bill is $40,000 for the year.

You determine that the cost driver impacting your utility bill is the number of direct labor hours worked. The number of direct labor hours worked totaled 2,000 hours for the year.

Divide your total utility bill by your cost driver (the number of hours worked) to get your cost driver rate. Your overhead application rate is $20 ($40,000 / 2,000 hours).

For this particular product, you used utilities for 4 hours. Multiply the hours by the cost driver rate =$80 (20×4)