How does activity based costing differ from traditional methods of applying overhead to products? Which one...

How does activity based costing differ from traditional methods of applying overhead to products? Which one is more advantageous and why? Be detailed with your response.

Expert Solution

Traditional Method of applying overhead:

Under this approach, entire overhead would be allocated to the products produced by different departments using a single cost driver say, labour hours, no. of units or machine hours. Eg., if the overhead is $560,000 and total direct labor hours are 80,000, overhead assignment rate would be $7 per direct labor hour ($560,000 / 80,000)

Activity Based Costing:

Under activity based costing, various cost drivers would be found for each and every department involved in the production process. Based on the quantity of cost driver used by the department the overhead would be applied.

For example, there are two departments Dept. A and Dept B. There are two cost pools say, Set up Costs of $50,000 and Assembly costs of $70,000. Total no. set ups are 25 and total no. of labor hours are 14,000.

Cost per cost driver quantity would be found and then it would be allocated to the department concerned with the actual usage of cost driver by the respective department.

More Advantageous:

Judging the advantages would be depended upon the type of the entity.

If the entity is engaged in producing a homogenous product, traditional costing is beneficial as activity based costing involves a lot of calculation and would be tedious.

If the entity is engaged in producing multiple types of products with different cost drivers, for best allocation of costs to the products, it is advantageous to follows Activity Based costing.

Hope it is helpful!!

ekkarill92 answered 1 year ago

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