Ayah Eca

Activity Based Costing with Four Activities Let’s add two more activities to our example: procurement and material handling. The costs of these two activities are not caused by—nor do they correlate with—machine hours. Rather, we will assume that both of these activities are related to the physical weight of the direct material used in making the product. The company determines that $300,000 of its annual manufacturing overhead is associated with procurement and material handling. As a result, the company removes $300,000 from the manufacturing overhead that will be allocated via machine hours, and instead plans to allocate the $300,000 to the products based on the weight of the materials used. The company expects that during the year it will procure and handle 3,000,000 pounds of material. Under activity based costing, the company will assign $0.10 ($300,000 divided by 3,000,000 pounds) per pound of product weight to each unit manufactured. The end result is that the heavier par...

Let’s illustrate the concept of activity based costing by looking at two common manufacturing activities: (1) the setting up of a production machine for running batches of products, and (2) the actual production of the units of product. We will assume that a company has annual manufacturing overhead costs of $2,000,000—of which $200,000 is directly involved in setting up the production machines. During the year the company expects to perform 400 machine setups. Let’s also assume that the batch sizes vary considerably, but the setup efforts for each machine are similar. The cost per setup is calculated to be $500 ($200,000 of cost per year divided by 400 setups per year). Under activity based costing, $200,000 of the overhead will be viewed as a batch-level cost . This means that $200,000 will first be allocated to batches of products to be manufactured (referred to as a Stage 1 allocation ), and then be assigned to the units of product in each batch (referred to as Stage 2 allo...

Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities. Let's discuss activity based costing by looking at two products manufactured by the same company. Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities. If this company used traditional costing, it might allocate or "spread" all of its overhead to products based on the number of machine hours. This will result in lit...