Activity Based Costing - Essay 2

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Assigning Overhead Costs – Overhead costs are not directly related to production volume, and therefore cannot be traced to units of product in the same way as direct materials and direct labor. Consequently, we must assign overhead costs using an allocation system.

There are three methods of overhead allocation 1. The single plant wide overhead rate method (as discussed in Chapter 2) Single overhead rate = Total budgeted overhead for the plant / Total budgeted base With base being direct labor cost, direct labor hours or machine hours 2. The departmental overhead rate method Each department will calculate its own overhead rate based on department’s overhead and its own base 3. The activity-based costing
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Under activity based costing, $200,000 of the overhead will be viewed as a batch-level cost. This means that $200,000 will first be allocated to batches of products to be manufactured (referred to as a Stage 1 allocation), and then be assigned to the units of product in each batch (referred to as Stage 2 allocation). For example, if Batch X consists of 5,000 units of product, the setup cost per unit is $0.10 ($500 divided by 5,000 units). If Batch Y is 50,000 units, the cost per unit for setup will be $0.01 ($500 divided by 50,000 units). For simplicity, let’s assume that the remaining $1,800,000 of manufacturing overhead is caused by the production activities that correlate with the company’s 100,000 machine hours.

For our simple two-activity example, let 's see how the rates for allocating the manufacturing overhead would look with activity based costing and without activity based costing:

| |With ABC |Without ABC |
|Mfg overhead costs assigned to setups |$200,000 |$–0– |
|Number of setups |400 |Not applicable |
| Mfg overhead cost per
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