Category: 

What is Activity-Based Cost Accounting?

Article Details
  • Written By: Osmand Vitez
  • Edited By: Kristen Osborne
  • Last Modified Date: 25 August 2016
  • Copyright Protected:
    2003-2016
    Conjecture Corporation
  • Print this Article
Free Widgets for your Site/Blog
Roughly one-fifth of the world's stock of gold - worth over $200 billion USD - is stored under the streets of London.  more...

September 30 ,  1949 :  The Berlin Air Lift ended.  more...

Management accounting is an internal form of accounting found in many businesses. A significant aspect of this accounting type is allocating the costs of goods or services produced by the company. Activity-based cost accounting is a particular form of cost allocation used in companies. It focuses on allocating costs based on cost drivers, which represents an activity that will add costs to goods or services. Although somewhat detailed and time consuming, activity-based cost accounting will often provide companies with the most accurate cost for the products they produce.

Three main costs exist in a cost accounting environment: direct materials, direct labor, and manufacturing overhead. Direct materials represents any physical item needed to produce a good, such as lumber, minerals, computer chips, plastics, or other items. Direct labor is the manpower associated with producing the product. Only the labor involved with the main production process is direct labor. Manufacturing overhead is the utilities or facilities cost that is the result of the production process. Each of these groups will have a cost driver for activity-based cost accounting; this is how costs are applied to the goods and services produced.

Ad

Direct materials allocation is fairly straight forward in activity-based cost accounting. The cost of each material needed to produce a good is the cost driver. Therefore, this is the cost for this specific portion of the accounting process. It can become complicated, however, if the company has multiple direct materials needed to produce a single unit. Accountants must be sure to include each cost on the portion of materials used in the product.

Direct labor is also easy to calculate in this cost accounting method. Each hour of labor — or partial labor hour — is a cost-driving activity. This results in the production labor cost to be directly allocated to the product. Similar to the allocation of direct materials, multiple individuals who work on producing the item must have the cost allocated, or companies will under-value the product and lose money on this portion of the process.

Manufacturing overhead is where the bulk of work occurs when allocating costs in an activity-based cost accounting method. Accountants will calculate the cost it takes the company to set up the production process for a good. This is common under the batch costing method, which is one of two common cost methods in management accounting. Accountants must then determine the best cost driver in which to use when applying manufacturing overhead, such as number of labor hours or machine hours required to produce a good. The process to allocate manufacturing overhead becomes total overhead costs divided by the total hours, which will give a per-unit cost to allocate to all produced goods or services.

Ad

You might also Like

Recommended

Discuss this Article

Post your comments

Post Anonymously

Login

username
password
forgot password?

Register

username
password
confirm
email