Activity base Costing simple definition :
'' Activity base Costing is the system in which we identify all the activities and calculate the total cost and then we calculate cost driver's rate on activity cost and after this we find total cost by multiplying cost driver rate with a particular product used in activities . "
Activity base costing (ABC costing) is the improvement of Absorption Costing System . It is known popularly as Modern ABC System of Cost Accounting .
Explanation with Example
Suppose , you have to make a Car and car is the the product which completes after 100 and more activity which we can for this we can make its 100 and more cost centers and its indirect cost can be calculated in each cost center which can be totalled and then we can calculated Cost driver rate after dividing total activity cost with nos. of cost driver . Cost driver means all the factor which affect production indirectly , it may include no. of machines setup , no. of employees , no. of other miscellaneous items. After multiply cost driver rate of one car production with total no. of times used on the basis of machine hour.
Main Steps of Calculating total Cost Under Activity based Costing
1st Step:
Identify the Activities
First of all we identify all activities in production . It may be 200 activity or more and on this basis , we can make Cost Centers .
2nd Step:
Calculate the Cost of All Activities
After finding and identifying the activities , we have to calculate total cost of every activity and then add it and calculate total cost of all activities .
3rd Step:
Calculate Cost Driver Rate
This is calculated with following formula = Total cost of all activities / No. of Cost Drivers
4th Step:
Calculate the total Cost of Product = Cost Driver Rate X No. of Machine Hour Time Used on Product
#example:
Samsung mobile company is producing two type of mobile. One is A mobile and second is B mobile. Machine maintenance cost is $ 4,00,000 and quality control cost is $ 6,00,000. For producing both type of mobile, total machine hours spent 10,000 Machine hours (5500 hours spent on A mobile and 4500 hours spent on B mobile). For producing both type of mobile, total inspections are 1000. Samsung is producing A mobile's 3000 unit and B mobile's 7000 units.
If this company will use old method of calculating per unit cost, then, Total overhead cost is $ 4,00000+$ 6,00,000 = $ 10,00,000. If we divide this overhead cost with total units, we will have per unit cost it will be $ 10,00,000 / 10,000 = $ 100 per unit.
Important : It is not exact cost because we do not care which overhead spend on what mobile. So, we will take care each activity. See following screenshot in 1st comment .
From above screenshot, you will find that Mobile A's per unit cost is $ 203 which is more than average cost per unit $ 100. Second Mobile B's per unit cost is $ 55.71 which is less than $ 100 average per unit cost.
Important : Activity based costing is 100 times better than traditional method of finding cost per unit because it is so close to exact cost of each unit's cost. With this, we can fix correct sale price. For example, B mobile's overhead cost is so low as per activity based costing, so, we will fix less sale price of this product. A mobile's cost per unit is high, so, we will fix more sale price of this product. Except this, if we have correct per unit cost, we can take many other good decisions like whether we have to continue any product or not.
'' Activity base Costing is the system in which we identify all the activities and calculate the total cost and then we calculate cost driver's rate on activity cost and after this we find total cost by multiplying cost driver rate with a particular product used in activities . "
Activity base costing (ABC costing) is the improvement of Absorption Costing System . It is known popularly as Modern ABC System of Cost Accounting .
Explanation with Example
Suppose , you have to make a Car and car is the the product which completes after 100 and more activity which we can for this we can make its 100 and more cost centers and its indirect cost can be calculated in each cost center which can be totalled and then we can calculated Cost driver rate after dividing total activity cost with nos. of cost driver . Cost driver means all the factor which affect production indirectly , it may include no. of machines setup , no. of employees , no. of other miscellaneous items. After multiply cost driver rate of one car production with total no. of times used on the basis of machine hour.
Main Steps of Calculating total Cost Under Activity based Costing
1st Step:
Identify the Activities
First of all we identify all activities in production . It may be 200 activity or more and on this basis , we can make Cost Centers .
2nd Step:
Calculate the Cost of All Activities
After finding and identifying the activities , we have to calculate total cost of every activity and then add it and calculate total cost of all activities .
3rd Step:
Calculate Cost Driver Rate
This is calculated with following formula = Total cost of all activities / No. of Cost Drivers
4th Step:
Calculate the total Cost of Product = Cost Driver Rate X No. of Machine Hour Time Used on Product
#example:
Samsung mobile company is producing two type of mobile. One is A mobile and second is B mobile. Machine maintenance cost is $ 4,00,000 and quality control cost is $ 6,00,000. For producing both type of mobile, total machine hours spent 10,000 Machine hours (5500 hours spent on A mobile and 4500 hours spent on B mobile). For producing both type of mobile, total inspections are 1000. Samsung is producing A mobile's 3000 unit and B mobile's 7000 units.
If this company will use old method of calculating per unit cost, then, Total overhead cost is $ 4,00000+$ 6,00,000 = $ 10,00,000. If we divide this overhead cost with total units, we will have per unit cost it will be $ 10,00,000 / 10,000 = $ 100 per unit.
Important : It is not exact cost because we do not care which overhead spend on what mobile. So, we will take care each activity. See following screenshot in 1st comment .
From above screenshot, you will find that Mobile A's per unit cost is $ 203 which is more than average cost per unit $ 100. Second Mobile B's per unit cost is $ 55.71 which is less than $ 100 average per unit cost.
Important : Activity based costing is 100 times better than traditional method of finding cost per unit because it is so close to exact cost of each unit's cost. With this, we can fix correct sale price. For example, B mobile's overhead cost is so low as per activity based costing, so, we will fix less sale price of this product. A mobile's cost per unit is high, so, we will fix more sale price of this product. Except this, if we have correct per unit cost, we can take many other good decisions like whether we have to continue any product or not.
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