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Calculating Activity Based Cost
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Calculating the activity based cost, its limitations and time driven activity based costing.
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Lecture 4: Using the Activity Based Costing MethodLast lecture was about the basics of ABC, how is it different from the traditional method and its
terminology. This lecture is about the calculation of ABC using an example.
Question: Manufactures two types of sophisticated control valves used in the food processing
industry. Valve A: main product for past 15 years. Valve B: introduced recently, is a more complex,
specialty valve used to control the flow of thicker foods such as pastes and sauces. Total budgeted
overhead £945,000. Departments: Equipment maintenance, Material handling, Quality Control,
Machining, Assembly.
Allocating the costs:
Calculate the cost per unit of activity driver
The cost of an activity is allocated on the basis of what is causing is, the activity driver. We then find
the cost per unit of the activity driver so that the cost can easily be allocated to the products. For
example in the case of setting up machines, we take our activity driver to be the number of setups
taking place and find the cost per set up. Similarly we find costs per unit driver for all the overheads.
Once we have the costs per unit drivers, we are ready to allocate these costs directly to the
products, or valves in this case, according to their consumption of the activity drivers.
Valve A requires 20 out of 120 machine setups and incurs the cost accordingly. Similarly valve B
requires 100 setups and therefore incurs majorit of the machine setup costs. Repeating the same
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