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In: Accounting

Overveiw: Activity Based Costing System and how its used. Explain how determining the overhead rate for...

Overveiw: Activity Based Costing System and how its used.

Explain how determining the overhead rate for each product activity will help with pricing of a product.

Solutions

Expert Solution

Activity-based costing (ABC costing) is a method used to arrive at a cost price for a product – the total of direct and indirect costs required for production by identifying and costing all associated business activities.

A brief example of how to conduct ABC costing:

  1. Identify the businesses main activities.
  2. Identify the activities’ cost drivers -- processes and activities that determine what a given activity costs the business, such as the number of orders.
  3. Assess the costs that go into each activity.
  4. Assign product costs based on rates of use of each activity.

Determing Overhead rate for each product activity will ease the process of analysis of cost of activity factor & helps in adding a markup on the cost.

Some activity might be less costly in general but due to human error, inefficiency, idle time, machine improvements etc such activity becomes more costly. By determing overhead rate for each product activity it crystallizes the weakness or exceptions, so that corrective & effective steps can be taken to reduce unnecessary increase in cost.Hence it helps in cost reduction ultimately helps in pricing of product.


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