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Activity Based Costing: Key Aspects

Introduction

Activity based costing (ABC) is commonly used because it gives detailed information on the cost of a product unit that is produced. Under activity based costing, the use of cost drivers is quite significant. These drivers are used to allocate total costs to a unit of the commodity produced. A cost driver is any factor that causes the cost of an activity to change. Thus, it creates a connection between the activities and the costs incurred. They are used for costs that cannot be allocated directly. The paper seeks to discuss various aspects of ABC.

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Question 1, 2 and 3

The answers to these three questions are presented in appendix 1 below.

Question 4

The total cost of an activity is assigned to a unit of output produced using a cost driver. The cost drivers are used in the preliminary and primary stage of cost allocation. Under the preliminary stage, a cost driver is used to determine the activity overhead rate per unit (Gupta, Sharma, Ahuja, 2006). For instance, assume that the total cost of producing equipment is $2,300,000. The corresponding cost driver is machine hours. If the total machine hours are 25,000, then it implies that the per-hour cost of production of equipment is $93. Thus, at the preliminary stage, the cost driver is used to determine the activity overhead rate. This provides a basis of allocating the cost of the activity to the units produced (Kinney & Raiborn, 2008).

Primary stage cost drivers

At this stage, the costs are directly allocated to the products. Thus, unit- and product-level costs are directly allocated to a product or they are grouped according to activities and later allocated to an individual product. However, facility- and product-level costs pass through several cost pools before being allocated to the product. From the previous section, equipment is manufactured using 10 machine hours. The resulting production cost per unit is $930 ($93 * 10). Thus, at the primary stage, the cost driver is used to estimate per unit cost of a product. All the cost hierarchies go through the preliminary stages before being allocated to the products.

Preliminary and primary stage cost drivers

It is important to use these two cost drivers because it allows a product to go through the stages of cost allocation. This ensures that the correct amount of costs is allocated to the product. Under the preliminary stage, costs are allocated to activities using the cost drivers while under the private stage; the costs are assigned to the products directly. Thus, if one stage is skipped then the products will be assigned an incorrect amount of cost (Bhattacharyya, 2011).

Conclusion

In summary, all costs should be analyzed and allocated accurately to ensure that the correct amount is allocated to the product. This will facilitate the calculation of the correct amount of profit. It also improves the decision making process.

References

Bhattacharyya, D. (2011). Management accounting: marginal costing and cost-volume-profit analysis, India: Dorling Kindersley (India) Pvt. Ltd

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Gupta, J., Sharma, A., & Ahuja, S. (2006). Cost accounting: marginal costing, New Delhi: V.K (India) Enterprises

Kinney, M., & Raiborn, C. (2008). Cost accounting: foundations and evolutions, New York: Cengage Learning.

Appendix 1

Question 1
Appropriate division
Question 2
Cost hierarchy
Question 3
Cost driver
Depreciation of factory equipment Operations Product-level cost Number of machine hours
Depreciation of office equipment Administrative Facility-level cost Number of machine hours
Depreciation of factory building Administrative Facility-level cost
Advertisement managers salary Sales Product-level cost Increase in sales
Assembly foreman’s salary Operations Facility-level cost Number of orders
Sales – person salary Sales Product-level cost Increase in sales
Sales persons travel expenses Sales Product-level cost Increase in sales
Supplies for the Machining department Operations Batch-level costs Number of batches produced
Advertising supplies used Sales Batch-level cost Increase in sales
Electricity for the assembly department Operations Facility-level costs Number of machine hours
Lost materials, (scrap) machining department Operations Facility-level costs Number of machine hours
Direct labor in the assembly department Operations Unit-level costs Number of direct labor hours
Supplies for the sales office Sales Product-level cost Increase in sales
Sales commissions Sales Product-level cost Increase in sales
Packing supplies Operations Batch-level supplies Number of batches produced
Cost of hiring new employees Administrative Facility-level costs Number of workers recruited
Payroll fringe benefits for workers in the shipping department Operations Product-level costs Number of workers
Supplier for production scheduling Operations Batch-level costs Number of orders
The cost of repairing parts improperly manufactured in the machining department Operations Batch-level costs Number of orders
Paints for the assembly department Administrative Facility-level costs Number of machine hours
Heat, light, and power for the factory Administrative Facility-level costs Number of machine operators
Leasing of computer equipment for the accounting department Administrative Facility-level costs Number of machine operators

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