Question

WHAT IS ABCs? Its Activities Based Costing and applies directly to how we apply/allocate our manufacturing overhead. So now get into it: a.) How is ABCs different than traditional costing/manufacturing overhead costing b.) How does ABC's work, in doing the calculations and applications c.) And why only relevant when dealing with a company making multiple products yet using the same common areas and materials/labor/overhead....

Answer 1

ABC is activity based costing. It is costing technique which is based activity performed. In this method overheads are allocated on the activity performed by each department.

• Under Traditional costing we apply the factory overhead on the basis of single absorption rate. The single absorption rate may be based on Direct labour hour, Total Machine hours etc. For example Factory overhead is 240000 $ and direct labour hour 2000 therefore overhead rate is 240000/2000 = 120 $ per hour. In ABC overhead are allocated on the basis of activity of the departments. So in ABC we have multiple overhead rate based on various activity. Cost driver includes Direct labour hour, Machine hour, output produced etc.
  
• Let us understand this with an example -

  • Activirty pool	Cost Driver	Total Activity	Total indirect Cost $	Unit cost
    Mchine set up	No of setups	2000	260000	130
    Purchase order	No of orders	1500	150000	100
    Packaging	No of product packaged	200000	2500000	12.5

    
    Now in above case we have developed rate for each activity pool seperately in column no 4. Suppose following activity are performed on product A.
    

    Cost pool	Activity performed	Overhead rate	Allocated overhead to product A
    Machine set up	500	130	65000
    Purchase order	150	100	15000
    Packaging	15000	12.5	187500

• For improving the costing accuracy and to know the true profitability of the indivdual products companies uses the activity based costing. In case of different common area of operation then overhead rate will give ambigous result. Therefore those companies having common base and producing multiple products ABC will be very useful.