Related article What is Lean Management Information System? And How Does It Work Objectives of Activity-Based Costing
The total overhead cost for product ABC incurred on electricity is $200 and the cost driver rate is $20. Therefore, the company makes use of electricity for 10 hours to manufacture the product ABC. In this case, that would be $100,000 divided by 5,000. To calculate the cost driver rate, divide the amount of money spent yearly on electric bills by the number of labor hours. Therefore, the cost driver for company XYZ about the production is 5,000. Let’s say that for the year 2018, the company’s labor hours were 5,000. The longer the labor hours, the more likely the electric bill will increase. Some of the places this type of costing is applied are in areas like service pricing, analysis of the profitability of a business, profitability analysis of a line of product, determination of the cost of products, and others.įor instance, if a company’s electricity cost is $100,000, the amount of time spent in production will have an impact on the bill. This helps the business to determine the cost incurred at each stage of the production process. The use of Activity-Based Costing in the manufacturing industry makes it possible to produce more reliable data. The use of Activity-Based Costing is more common in industries where the manufacturing of products is carried out. There are, however, some kinds of indirect costs that may be difficult to allocate to products. This cost allocation is less arbitrary and more realistic than the traditional cost allocation methods. This method of costing recognizes that a relationship exists between the costs incurred and every other activity going on in the business.Īctivity-based accounting makes it possible to assign an indirect cost to different products or services offered by the business. Activity-based costing or ABC is popularly referred to as a method of costing whereby overhead costs are assigned to products and services.