Under the traditional overhead analysis overheads are not linked to the production departments very accurately.
Accordingly, activity based costing approach has been designed which identifies cost drivers that cause incurrence of overhead. Cost drivers are major activities of service departments. Time taken to perform a service has been recorded against each cost driver. Overhead are allocated and absorbed on the basis of time spent.
For example, cost drivers of stores department are
- receiving materials
- issuing materials
- maintenance of stores ledger
- upkeeping stores
- physical verification
Time consumed by the staff of stores department and calculation of cost per unit of time is necessary step n activity based costing. Say, receiving section’s total cost is $ 100,000. The total working hours are 10,000. So cost per hour of this cost driver is 10$. Similarly it is necessary to calculate cost of other cost drivers.
Now time consumed for rendering service to the production department is recorded. Overhead is apportioned by multiplying cost per unit of time for each cost driver with time of that cost driver consumed.
However, identification of cost drivers & recording time spent against each cost driver is very laborious as well as expensive job.
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