Question

Activity-based costing involves four steps what are they? Explain.

Answer 1

Activity Based Costing is a technique which involves identification of cost with each cost driving activity and making it as the basis for assignment of costs over different cost object.

Steps involved in Activity Based Costing:-

There are four steps involved in Activity Based Costing as below:-

1. Identification the Activities.

2. Identification of Activity cost drivers

3. Calculation of Cost Drivers rates.

4. Cost Assignment.

These can be described as follows.

1. Identification of Activities.

In this step identification to be done of various activities within the firm. Such as purchase of materials, maintenance of equipments, testing of products etc. identification of overheads for the activities also done in this step such as purchase manager salary, purchase order processing cost, tenders, advertisement can be the overheads for purchase of material activity and salary of maintenance engineer and consumables can be the overheads for maintenance of equipment activities and salary of testing staff, depreciation on testing equipments can be the activities for testing of product activities. So in this step identification of activities and identification of overheads related to the activities has to be done.

2. Identification of Activity cost drivers

Cost driver is the factor that causes a change in the cost of an activity, in this step one has to determine the activity cost drivers for each activity. Activity cost drivers are used to relate the overheads to activities. These can be as number of purchase orders, number of hours, number of units tested for purchase of material, maintenance of equipment and testing of products activities.

3. Calculation of Cost Drivers rates

In this step of activity based costing one has to calculate cost rate per cost driver. This has to be calculated for each activity such as $10 per purchase order for purchase order cost driver, $20 per maintenance hour for maintenance hours, $2 per unit tested for number of unit tested cost driver.

4. Cost Assignment

In this steps assignments of the costs to the cost object has to be done using the formula as recourses consumed x activity cost driver rate. So for example we assume that a job required 20 purchase orders and 40 hours of maintenance and total produced 50 units to be tested than the purchase order cost for the job will be 20 x 10 = 200 , maintenance cost will be 40 x 20 = 800 and testing cost would be 50 x 2 = $100. So by this total overhead cost will be $1100 for 50 units i.e. $22.

So above description discuss about the four steps involved in Activity Based Costing with examples.