Quiz 18: Activity-Based Costing

Business

Activity Based Costing (ABC): It is an accounting methodology that identifies the activities that a firm performs and determines the cost of each activity, the cost of each activity is then assigned to the products and services. It is a technique used to determine the product cost or product lines. The focus of the ABC analysis is to identify the relationship between resources, activities and cost objects. Under ABC, resources are being consumed by activities and activities are being consumed by cost objects, where activities are action or work performed by the organization and cost objects are patients, service. It can be understood with the help of given example: if some cost of material department is related to routine standard order and some related to special order. It needs to be considered by the department that special order will be expensive. Thus the focus of ABC in this case is that the cost of special order is allocated to the right products or services. Thus, it can be concluded that focus of ABC is optimal allocation of cost of each activity directly to the products and services.

Activity Based Costing (ABC) : In traditional costing approach, costs are assigned to product or service. It is effective only when costs are direct costs. In the case of indirect costs, it is difficult to allocate costs. This problem is solved in Activity Based Costing as it allocate costs to activities involved in product or service rather than to product or service itself. In the given problem, W hospital was allocating all its maintenance costs to departments on the basis of departmental square feet. But now it is considering using ABC approach for cost allocation for maintenance cost related to repair. We need to calculate cost assigned to pharmacy department using both methods. Computation of Costs allocated to department on the basis of existing method is as follows: 1. Existing method : In this method, all costs are assigned on the basis of departmental square feet. img Total labor hours for all departments having total volume of 100,000 square feet are 14,000 hours. img The total labor cost per hour is $13.71. img Total supplies for all departments having total volume of 100,000 square feet are $100,000. img Total administration cost for all departments having total volume of 100,000 square feet are $15,000. img Computation of Total cost of Pharmacy department is as follows: img Thus the value of total cost of pharmacy department has been computed above as img . 2. ABC method : In this method, maintenance costs related to repair are assigned differently. For pharmacy department, labor hours for repair are 6 hours with cost of $18 per hour. The other labor hours can be allocated on the basis of square feet which are img . These labor hours have cost of $12 per hour. img For pharmacy department, supplies used for repair are $200. The other supplies can be allocated on the basis of square feet which are img . img In both the cases, administration costs shall remain same what it is in above method $300. Computation of Total cost assigned to pharmacy department is as follows: img

Resources : It is defined as economic or productive factors which are required to accomplish an activity. These are the elements which are used by an enterprise to achieve desired results. Resources is one of the elements of activity based costing (ABC) which includes economic or productive elements that are used to perform activities. Example: materials, capital and salaries. ABC: It is an accounting methodology that identifies the activities that a firm performs and cost of each activity is determined, the cost of each activity is then assigned to the products and services. It is technique used to determine the product cost or product lines. In traditional approach of cost accounting, resources are directly consumed by the products and services. Under ABC, resources are being consumed by activities and activities are being consumed by cost of products and services.