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Chapter 36. Activity-Based Costing. Prepared by Diane Tanner University of North Florida. Trend Towards Indirect Costs. 2. Automated manufacturing environments experience overhead costs that exceed 60% of total product costs Recent trends Reduction of direct costs
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Chapter 36 Activity-Based Costing Prepared by Diane Tanner University of North Florida
Trend Towards Indirect Costs 2 • Automated manufacturing environments experience overhead costs that exceed 60% of total product costs • Recent trends • Reduction of direct costs • Creates greater indirect costs • More services provided • Very little direct costs • High levels of indirect costs
What is ABC? 3 • A system of allocating overhead costs based on activities that drive costs rather than on the volume or number of units • Alternative method to traditional MOH allocation which is based on volume
Decision making Reduce frivolous use of resources Evaluate the efficiency of services Provides full cost information - GAAP Why Do We Allocate Overhead Costs? 4 Only indirect costs are allocated/assigned. Direct costs are traced.
Assigning Overhead Costs to Products/Services 5 • Traditional allocation • A single “plant-wide” overhead rate used for entire factory • i.e., Use one POHR • Simple to use • Traditional allocation bases • Direct labor cost • Direct labor hours • Machine hours • Units produced
Concerns of Using One Overhead Rate 6 6 • Can distort unit product costs • Direct labor not highly correlated with overhead costs • Not all overhead costs increase for the same reason • Single allocation basis does not reflect the activity for all overhead costs
A Better Allocation Method 7 Cost Pool Cost Object Cost Driver Activity-Based Costing A number of allocation bases are used for assigning costs to products/services
Definitions 8 Cost PoolA “cost bucket” in which costs related to a particular activity are accumulated Cost Driver An activity/event that causes consumption of costs; i.e., causes costs to increase Cost ObjectThe product, service, contract, job, etc. for which you want to accumulate costs
How to Perform ABC 9 Step 1: Calculate the rate for each cost pool. Estimated Cost / Estimated Activity = Rate Step 2: Multiply each cost pool rate times the respective actual activity. Step 3: Total up the amounts from step 2. This results in the applied overhead cost. Step 4: Add to the direct costs of each cost object to obtain the total cost of the cost object(s).
