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The different stages in activity based costing are listed below
(1) Identification of the activities that may take place in an organisation : The first stage is to identify the major activities in the organization. There can be machine related activities, direct labour related activities and various support activities such as ordering, receving, material parts handling etc. The activities may be listed as follows:-Production schedule changes
• Customer liaison
• Purchasing
• Production process set up
• Quality control
• Material handling
• Maintenance
(2) Assigning costs to cost pool for each activity both support and primary activities, that caused them. This creates ‘cost pools’ or ‘cost buckets’. This will be done using resource cost drivers that reflect causality.
(3) Support activities are then spread across the primary activities on some suitable base, which reflects the use of the support activity. The base is the cost driver that is the measure of how the support activities are used.
(4) Determine the cost drivers for each activity that will be used to relate the overheads collected in the cost pools to the cost objects/products. A cost Driver is a variable, which determines the work volume or work load of a particular activity. This is based on the factor that drives the consumption of the activity. The question to ask is – what causes the activity to incur costs ? In production scheduling, for example, the driver will probably be the number of batches ordered. Some questions which are aimed at bringing out the cost drivers are given below:-
• What is the number of staff working on a particular activity?
• Why is overtime worked?
• Why does the idle time occurs?
• What is it, that determines the amount of timew spent on a particular activity?
The end result of this type of questioning will be a typical set of cost drivers for each sub-activity.
(5) Assigning the costs of activities to products according to product demand for activities : This step involves tracing the cost of the activities to products according to products demand for these activities during the production process. This requires to calculate cost driver rate for each activity, just as an overhead absorption rate would be calculated in the traditional system.
Activity cost driver rate =Total cost activity/Activity driver
The activity driver rate can be used to cost products, as in traditional absorption costing, but it can also cost other cost objects such as customers/customer segments and distribution channels. The possibility of costing objects other than products is part of the benefit of ABC. The activity cost driver rates will be multiplied by the different amounts of each activity that each product/other cost object consumes.
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