Activity Based Costing Flashcards
OVERHEADS
All costs which are not direct materials, direct labour or direct expenses.
Usually divided by function e.g. production overheads s&d overheads R&D overheads Administration o/h Can be fixed, variable or semi variable
What are the four main steps in dealing with overheads in a “traditional system”?
- Collection
- Classification
- Allocation and Apportionment
- Absorption
Step 3 of allocating overheads: ALLOCATION AND APPORTIONMENT
Must decide how to divide overheads among department (cost centres or cost pools).
ALLOCATION
Where whole items of cost ca be charged to a cost centre.
APPORTIONMENT
Where overheads must be shared between more than one cost centre.
Describe the format for charging overheads to departments.
Six stages:
- List overheads as rows.
- Show cost centres (production and service departments or cost centres) as columns.
- Allocate overheads where amounts and cost centres are known.
- Decide basis of apportionment and apportion remaining overheads.
- Total overheads for all cost centres.
- Reallocate and reapportion service cost centres to production cost centres.
Step 4 of allocating overheads. ABSORPTION
How to share production departments’ costs by charging overheads to individual cost units through the production departments
Need to find absorption and base rate
Bases of absorption should reflect demands made by cost unit on production facilities.
Examples of possible bases:
- Direct labour hours
- Direct machine hours
- Direct materials
- Direct wages
- Number of cost units
- Prime cost
How are absorption rates calculated?
Total cost centre overhead / overhead base
Can have a blanket overhead (whole factory)
For each production centre department (departmental overhead rate)
When are traditional costing systems appropriate?
- Direct costs were the dominant costs
- Indirect costs (overheads) were relatively small.
- Information costs were high.
- There was a lack of intense global competition.
ACTIVITY BASED COSTING
Developed when new technology meant that overhead costs can be much higher than direct labour costs, therefore traditional methods are inappropriate.
ABC collects overheads into cost pools (or cost centres).
ABC charges costs to the products or services according to the consumption of the activity (cost driver) which causes (thus the allocation and absorption processes capture costs in a different way).
Attempts to absorb o/h costs more accurately in order to reflect the resources consumed by producing the product or service.
ACTIVITY
An action or an aggregation of actions performed within an organisation.
RESOURCE
An economic element needed or consumed in performing activities
COST DRIVER
An activity or characteristic that consumes resources.
COST CENTRE/COST POOL
Used to describe allocation to which overhead cost are initially assigned.
Costs from activity cost pools are assigned to cost objects using cost drivers.
When should ABC be implemented?
- The cost of measuring the activities and their costs is reduced, perhaps because of computerised scheduling systems on the production floor.
- Stronger competition increases the cost of errors caused by erroneous pricing.
- Product diversity is high in volume, size, or complexity.