Answer First
Activity‑Based Costing assigns overhead based on activities rather than a single plant‑wide rate. To compute ABC, group overhead into cost pools, compute an activity rate for each pool, and allocate overhead to products based on their usage of each activity.
Problem Setup
For each activity:
- Cost pool: total overhead for the activity
- Cost driver: measure of activity usage
- Activity rate: \[ \text{Rate} = \frac{\text{Cost Pool}}{\text{Total Cost Driver Units}} \]
Product overhead: \[ \text{Overhead Assigned} = \text{Rate} \times \text{Product’s Driver Usage} \]
Step-by-Step Explanation
1. Identify activities and cost pools
Examples:
- Machine setup
- Quality inspections
- Material handling
2. Choose cost drivers
Examples:
- Number of setups
- Inspection hours
- Material moves
3. Compute activity rates
Divide each cost pool by total driver units. Example: \[ \text{Setup Rate} = \frac{120{,}000}{300 \text{ setups}} = 400 \text{ per setup} \]
4. Allocate overhead to products
Multiply each activity rate by the product’s usage of that activity.
5. Sum across activities
Total overhead per product is the sum of all allocated activity costs.
Intuition
ABC recognizes that products consume activities, not just machine hours. High‑complexity products use more activities and therefore receive more overhead. Low‑complexity products receive less.
Common Exam Mistakes
- Using a single plant‑wide rate instead of activity rates.
- Mixing up cost pools and cost drivers.
- Forgetting to compute total overhead per product.
- Incorrectly summing activity usage across products.
Final Summary
To compute Activity‑Based Costing, create cost pools, choose cost drivers, compute activity rates, and allocate overhead based on each product’s usage of activities. ABC provides a more accurate measure of product cost than traditional overhead allocation.
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