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Chapter eight - The activity based approach to overheads - Coggle Diagram
Chapter eight - The activity based approach to overheads
Activity based terminology
Activity: an activity is an event or a process in the manufacture of a product or delivery of a service. For example, setting up machines
an overhead cost driver is any factor which causes a change in the cost of activity. This means that the greater the volume of the cost driver the higher the related overhead costs. Examples would be setting up a machine and several setups
an overhead cost driver rate is calculated by dividing the total overhead cost for an activity by the total cost drivers for the activity. An overhead cost driver rate is calculated separately for each activity thus there are typically many more overhead rates when ABC is used
the primary objective of ABC is to provide accurate product/service costing information. ABC assumes that overheads are caused by activities IE more and activity is repeated the greater the amount of overhead costs incurred.
Setting up an ABC system
step one - identify major activities (cost pools)
Step 2 - identify overhead cost drivers for each activity
Step 3 - accumulate cost effectivity into overhead cost pools
Step 4- calculate overhead cost driver rates to assign cost to products
activity based costing makes waste more visible
activity based costing can help to identify slash eliminate nonvalue added activities. When the cost of an activity is calculated management can analyse these costs to try and identify which costs do not add value to their products/services. For example, the cost of moving items from one part of a factory to another will add cost but not value
ABC emphasizes that activities have costs. This identification of activities and overhead cost pools focuses management attention on understanding how costs arise in the type of extent of these costs. It is especially helpful for businesses producing products which differ in volume and in the activities, they require and in situations where overheads are high and increasing without apparent reason
improves the accuracy of product and serving costing. Specific overhead cost is matched to the activity that give rise to it and from there to the product. Assignment of overhead to products using overhead cost rate is based more on A cause and effect relationship rather than a veterinary volume-based approach that simply considers volume of output
benefits of activity-based costing
limitations of activity-based costing
ABC systems are expensive to develop and maintain. Setting up an ABC system requires significant time and effort often necessitating the collection of data for which there is no previous requirement
Identifying activities overhead cost pools and overhead cost drivers is a subjective exercise
Implementing ABC whereby a different focus is placed on activities and costs may have been behavioural implications in that there may be some resistance from staff on or management to the new product costing system