The Activity-Based Costing Process

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  • 0:03 Activity-Based Costing
  • 0:38 Using Activity Cost Pools
  • 1:13 Finding Activity Rates
  • 2:04 Assigning Overhead to…
  • 2:44 Reporting it All
  • 3:05 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

With computers, it's now possible to provide costs for virtually every activity that touches a product. In this lesson, we'll learn about the activity-based costing process and how it works.

Activity-Based Costing

Technology has had a massive impact on plenty of areas in business. Accounting is no different. With the development of computer-based spreadsheets that can quickly calculate otherwise cumbersome numbers, managers are able to track costs with better accuracy than ever before. This has led to a rise in the use of activity-based costing, a method of tracking costs as they are applied to each unit, batch, product line, or facility of production. In the past, managers had to lump all overhead expenses into one broad category. Now, they are able to track them more closely than ever before.

Using Activity Cost Pools

First things first, we have to determine where a cost goes. That means putting it in the proper activity cost pool. An activity cost pool tells us where the cost is coming from. For example, an accounting expense would have an accounting department as the activity cost pool. From here, we can also find out the activity cost driver, which is the actual expense categorized. The accounting department may increase overhead expenses by preparing tax returns, but it may also increase expenses by making sure that employees are paid. Either one of these can be a cost driver within the cost pool of the accounting department.

Finding Activity Rates

Next we have to find the activity rates. An activity rate is the cost of a particular cost driver divided by the relevant number of units produced. Remember earlier, we talked about how costs could be tracked for multiple levels of production, or by the unit, batch, product line, or facility? This is where it comes into use. The activity rate is found by dividing the number of applicable units by the cost of the cost driver. So let's say your factory made 100,000 widgets last month and accounting spent $10,000 on paperwork for salaries. This would mean that the cost driver, 'paperwork for salaries,' would have an activity rate of 10 cents per widget. Meanwhile, if there was a special order that required a batch of 100 widgets to be made, but only that batch had an additional cost of $500, then each widget in that batch would have an extra activity rate of $5.

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