Broadening Your Prospectives
Broadening Your Perspective
Abstract
The purpose is to describe the use of activity based costing and its benefits. For this purpose, the R&D cost of Ideal Manufacturing Company has been used. The comparison of activity based costing with conventional method has been done. Finally, the benefit of use of activity based costing has been described.
Activity Based Costing
The cost of a product comprises of direct material, direct labor and overheads. It is easy to trace direct material and direct labor to a particular product. But it is not easy to trace directly all overheads to a particular product to determine its product cost. For example, if a company pays $200000 as rent of factory, it can not be said for which product it has been paid. It is absorbed to the product cost, on some arbitrary basis or assumption. If company decides to produce 10000 units, then the factory rent will be dividend by 10000 units to arrive at $20 per product for rent or if company decides to produce 20000 units the rent to be charged $10 for each product. The method is conventional and very easy to use. But it is not necessary that the overhead rate determined is the true representative of the resources used by the product.
The activity based costing helps in allocating cost to the product according to the resources used by each activity. The Ideal Manufacturing Company total overheads of R&D department is $8.4 million, if company uses the conventional method of overhead, the rate on the basis of number of hours is 8400000/15000 = $560 per hour. Under this method, the R&D cost to in house department is 1800*560 = $1008000 and to outsider it is 800*560 = $448000. As the company is deciding to use activity based costing, and there are four activities therefore the rate of each activity is determined and it is as follows:
Market Analysis
$ 70
per hour
Product Design
$ 940
per design
Product Development
$ 40,000
per product
Prototype Testing
$ 2,800
per test
The above rate is the true representative of the cost related to its driver. Now the each activity rate is used to determine the R&D cost being charged to in house department and it is as follows:
Market