Activity Based Costing
What is Activity Based Costing?
With activity based costing, overhead costs are caused by various activities.
![abc 1](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-1.jpg)
How it Works
One of the three costs you need to track in manufacturing is manufacturing overheads.
![abc 2](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-2.jpg)
Traditionally, you would use machine hours or labor hours to ascertain these costs.
![abc 3](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-3.jpg)
For example, you would estimate total labor hours required to make a batch of goods.
![abc 4](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-4.jpg)
Then you multiply this by the hourly wage rate.
![abc 5](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-5.jpg)
This would show the total labor cost for the batch.
![abc 6](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-6.jpg)
To find the unit cost of those goods, you divide total overhead cost by total units produced.
![abc 7](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-7.jpg)
This gives a cost per unit.
![abc 8](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-8.jpg)
In future costings, you multiply this unit cost by the number of units produced in the batch.
![abc 9](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-9.jpg)
This would show the manufacturing overhead portion of costs for the batch.
![abc 10](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-10.jpg)
Activity Based Costing
Traditional costing is quick and easy, but a manufacture may make many different products.
![abc 11](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-11.jpg)
With traditional costing, the assumption is that all products use an equal amount of indirect overhead costs.
![abc 12](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-12.jpg)
In reality, though, some products require more overheads than others.
![abc 13](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-13.jpg)
For example, some products may need more time for machine setup.
![abc 14](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-14.jpg)
Other products may need more time for inspections.
![abc 15](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-15.jpg)
The time needed for cleaning may also vary.
![abc 16](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-16.jpg)
Even packaging costs can vary from one product to the next.
![abc 17](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-17.jpg)
In activity based costing, all of these things are known as activities.
![abc 18](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-18.jpg)
By determining overhead costs based upon these activities, the manufacturer can obtain a more refined unit costing than they can with traditional costing methods.
![abc 19](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-19.jpg)
How activity based costing works — Step by Step
Set Up Activity Information
- Identify the activities that are driving costs.
![abc 20](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-20.jpg)
- Classify each activity according to the cost hierarchy—unit level, batch level, product level, or facility level.
![abc 21](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-21.jpg)
- Identify the cost driver of each activity.
![abc 22](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-22.jpg)
- Calculate the cost driver unit price.
![abc 23](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-23.jpg)
- Estimate the required number of cost driver units.
![abc 24](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-24.jpg)
- From this information, determine the total costs involved in each activity.
![abc 25](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-25-1.jpg)
Apply Costs to Products
1 Estimate each product’s usage of indirect overhead costs.
![abc 26](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-26.jpg)
- Take the total costs involved in each activity.
![abc 27](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-27.jpg)
- Then apportion those costs to each product—based on usage.
![abc 28](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-28.jpg)
- Set out the total units to be produced.
![abc 29](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-29.jpg)
- Calculate the cost per unit
![abc 30](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-30.jpg)
- Calculate total indirect overhead costs of each unit produced.
![abc 31](https://seeaccountingnow.online/wp-content/uploads/2021/08/abc-31.jpg)