Let’s calculate the activity based costing of the same
product with two different manufacturing activities. In the first activity the
firm has set up a machine to run and produce the batches of the product. In the
other manufacturing activity the production is done by producing specific units
of the product. Let’s assume that the annual over head production cost of the
company is $2,000,000. Out of this total coast about $ 2, 00,000 is spent in
actually setting up the machines involved in production. Each year company sets
up almost 400 machines to complete the production.
The cost involved in each setup can be calculated as follows
Setup cost = Total Set up Cost/ Number of machine setups
Setup Cost = 2, 00,000/ 400
Setup Cost per machine= $500
This overhead will be viewed as the batch level cost or the
cost of the Stage 1 of the production. This cost is first assign to produce the
batches of the product then it will assign to produce the units of the product.
This will be called as the Stage No 2 of the cost allocation. Now let’s assume
that a batch consists of 5000 units of products the overhead cost associated with
setup for each unit can be calculated as follows:-
Setup Cost for each unit = Setup Cost of a Machine/ Number of
unites produced by that machine
Setup Cost for each unit= 500/ 50,000
Setup cost per unit = $0.10
Now let’s have a look that cost of over head allocation to
the manufacturing is done with activity based modal and without activity bases
modal.
|
|
With Activity Base
Costing
|
Without Activity
Based Costing
|
|
Overhead costs
involved in setups
|
$2,00,000
|
$0
|
|
Number of Setups
|
400
|
Not available
|
|
Cost per setup
|
$500
|
$0
|
|
|
|
|
|
Total overhead mfg
cost
|
$,2000,000
|
$2,000,000
|
|
Machine Setup Cost
|
200,000
|
0
|
|
Overhead cost on
machine hours
|
$1,800,000
|
$2,000,000
|
|
Machine Hours
|
100,000
|
100,000
|
|
Overhead cost per
Machine hour
|
$18
|
$20
|
|
|
|
|
|
Over head cost
allocation
|
$500 setup cost +$18
per MH
|
$20 PER Machine Hour
|
Now let’s calculate over head cost of setup associated with
each unit produced. This cost is calculated for a batch of 5000 units.
|
|
With Activity Base
Costing
|
Without Activity
Based Costing
|
|
Overhead in setting
up machine
|
$500
|
$0
|
|
Number of Units in
batch
|
5000
|
Not available
|
|
Overhead per unit by
setup
|
$.10
|
Not Available
|
|
|
|
|
|
Overhead cost per
Machine hour
|
$18
|
$20
|
|
Number of units / MH
|
50
|
50
|
|
Over head cost per
unit
|
$0.36
|
$0.40
|
|
Total Over head cost
per unit
|
$0.46
|
0.40
|
Now the tables show that overhead cost calculated by activity
based costing is greater as compared to calculated by traditional costing
method. This means activity based costing method is more accurate and precise.
