Activity Based Costing

 

Activity-Based Costing

Introduction

The production activities in a company are both associated with the costs incurred as well as the profits to be made.  Thus, it becomes very important for a firm to understand all the costs it incurs and how to, therefore, price her services or products according to the way that has been established that it will be profitable. There are many traditional methods used to account for coasts as well as modern methods.  The modern methods have proven to be more efficient and straightforward whereas the traditional methods have proved to be inconsistent with their cost assignments and estimations.

The modern methods include the activity based costing method and are the one that I will largely talk about in this assignments while comparing it to the normal way and see the difference in the values obtained.

The case study

Merit-o-cracy PLC, which is a specialist-advertising agency, has been one example that will show the transition from the traditional costing methods to the modern ways. The case study spells out the various accounts of costs which are making the company to just win the smaller advertising projects that he big advisement campaigns.

Thus, what could just be the difference in the approach used? For this, I will have to find the allocation of costs to the small size advertising as well as the big or large size advertisements campaigns. From the case study, the amount of overhead allocated to small and large advertising campaigns under the existing methods will be calculated as follows:

Total pricing = space or time purchase + 100%

This means that for the 350 advertising campaign spaces, the total cost will be

This hence means that the rules as stated in the case study are still obeyed that on the direct costs of advertisements, there is 100% additional cost to cater for the overhead costs and the total amount of costs has just confirmed it.

Application of the activity based costing on every cost per cost driver

For activity-based costing, there is the allocation of the overhead to the items that actually use it. Thus if the company wants to target a reduction of its overhead costs then it has to spread its costs to only what it was working with that is the campaigns that were going to earn for the company or simply cost it but not on campaigns that will not mature.

Hence, the cost pools are as listed below

The advertisements spaces that will be bought for the large and small campaigns, creative staff, production staff, administration, support, and the rentals and associated costs. The cost has to be proportional in all aspects of the creative department, the production and the administration as well as the associated costs. Hence, I will look at the cost of 350 campaigns, which have been spread as 325 small campaigns and 25 large campaigns.

Looking at the ratio of the respective costs, 1 small campaign costs $4000 and 1 large campaign costs $28000. Thus for two both large and small campaigns will cost a total of $32000. Their respective proportions of the cost are, the small campaign’s proportion is 0.125 and the large campaign’s is 0.875.

Therefore, each departmental breakdown is going to be as follows;

Creative staff

800 (400 small +400 large) advertisements =$500000

Meaning that, for small advertisement= 0.125 X $500000=$62500

For large advertisement = 0.875 X $500000 = $437500

The large advertisement that were successful, =25/400 X $437500 = $27343.75

The small advertisement that were successful, = 325/400 X $62500 = $50781.25

Total creative staff overhead = ($27343.75+ $50781.25) = $78125

Production staff = $750000

Administrative & support staff =$300,000

Rental and associated costs = $450,000

The advertising costs =$2000000

The total activity-based overhead applicable to small and large campaigns

Total will be the sum of the new cost per pool drivers

Total = ($78125+$750000 + $300,000 + $450,000 + $2000000) =$3578125

The percentage to be added to direct advertising costs to recover overhead costs under activity-based costing

The percentage is the difference between the original amount and the new value worked on as a percentage;

Whereby we shall have

The above percentage also indicates how more expensive the traditional costing inflates the actual cost or how cheaper it looks when the activity-based costing will indicate costs of advertising.

Hence, therefore so that the company may actually identify the best way to control the costs that the company incurs while in its lines of operations.

References

Cokins, G. (2001). Activity-based cost management: An executive’s guide. New York: Wiley.

Hicks, D. T. (2002). Activity-based costing: Making it work for small and mid-sized companies.

INSTRUCTOR RESPONSE:

 This week we will learn about a new way of establishing overhead rates to allocate indirect costs. This is called ABC or Activity Based Costing. Attached please find a template that may help you work out the numbers for the case this week. Our discussion need to be around what is used in the calculations and why. Why do companies use ABC rather than just direct labor hours to allocate overhead? 

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