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International Accounting Session 9 – Cost Allocations and Activity-Based Costing Dr. Othman Cole othman.cole@faculty.hult.edu 1 Absorption Costing In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product. Units are said to fully absorb manufacturing costs. Most countries require some form of absorption costing for both external financial reports and for tax reports. Also, most companies across the world use absorption costing in their management reports. It is the most common approach to product costing throughout the world. It is also known as Job-Order Costing. 2 Absorption Costing – Components • Direct Materials – can be easily traced to a particular unit • Direct…show more content…
b. What is the unit product cost for the month under absorption costing? c. Prepare a contribution format income statement for the month using variable costing. d. Prepare an income statement for the month using absorption costing. 10 Activity-Based Costing In activity-based costing (ABC), nonmanufacturing as well as manufacturing costs may be assigned to products (on a cause-and-effect basis). Further, some manufacturing costs may be excluded from product costs. An ABC system uses a number of overhead cost pools, each of which is allocated to products and other defined cost objects using its own unique measure of activity. In contrast to traditional absorption costing which is used mostly for external financial reporting, activity-based costing is particularly useful for internal and strategic decision-making. 11 Activity-Based Costing – key features • An activity is defined as any event that causes the consumption of overhead resources. • An activity cost pool is a “bucket” that accumulates all costs related to a single activity measure. • An activity measure is an allocation base in an ABC system. It is also referred to as cost driver. § Transaction drivers – number of times an activity occurs § Duration drivers – amount of time required to perform an activity 12 Activity-Based Costing – key steps 1. Define activities, activity cost pools, and activity measures. 2. Assign ALL overhead costs to activity cost pools (first-stage
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