Activity Based Costing
Essay by emhaii • January 21, 2018 • Research Paper • 1,629 Words (7 Pages) • 1,044 Views
Introduction
Activity based costing is a method of calculating costs that focus on discovering activities that incur cost and assign cost to these activities to ensure that costs are accurately measured. The ABC method often uses two kinds of cost drivers, including transaction drivers and duration drivers. Transaction driver determines the number of time a particular activity occurs. Meanwhile, duration driver determine how long each activity takes. (Activity-Based Costing - ABC, no date).
Case study
Applying the acvity based costing method to the case study in question, we would need to follow five steps:
Step 1. Identify activities that are required to deliver products and services.
The tasks that the company performs to complete the tax return service can be divided into two cost pools – hour pool and return pool.
Hour pool: contain tasks that take hours to complete. Hour is the driver of this activity pool. The activities that belong to this activity pool are: interview client, input data, and verification.
Return pool: each return will incur additional cost. Return is the driver of this activity pool. Activities that belong to this activity pool include: obtain missing data, rectification of data error, and submission of return, annual license and processing fee. However, there are some exceptions to activities in this pool. In particular, rectification does not happen to all returns, it would not be counted in all tax returns. It would only be counted in 22 individual returns and 1,065 business returns. Similarly, annual license fee and return processing fee only apply to business returns, as well as follow-up conversations that applies to business customers. Therefore, these are the cost pools that would be allocated towards business returns.
Due to the above characteristics, we would further divide the tax returns into 4 types: individual (without error), individual (with errors), business (without errors), and business (with errors). We would want to keep products separated this way since they will make pricing more transparent for customers and the company as well.
The calculation will have to exclude some activities during the first phase of overhead calculation, and include its in the second phase. This is the returns that have to be rectified for errors, since they are exceptions and do not belong to the standard process. In addition, individual returns would not incur follow up costs, so the overhead cost of obtain missing data would also be excluded.
Activity | Cost pool | Overhead cost | Cost driver activity | Overhead rate |
Interview client | Hour | 1,615,000 | 19,000 | 85 |
Obtain missing data | Return (business only) | 800,000 | 9,000 | 88.88889 |
Input data | Hour | 390,000 | 9,750 | 40 |
Verify return with client | Hour | 875,000 | 8,750 | 100 |
Rectify errors | Return (Phase 2) | 40,000 | 1,087 | 36.79853 |
Submit return | Return | 50,000 | 12,000 | 4.166667 |
Total hours spent on verification would be : 3000 * 10/60 + 9000 * 55/60 = 8,750
Therefore, the overhead rate for each activity would be calculated as : overhead cost/ cost driver activity. We would then assign the overhead rate by hour driver by calculating the total number of duration that it takes to complete each service.
Step 2. Assign overhead costs to the activities identified in step 1.
Step 3. Identify the cost driver for each activity.
Step 4. Calculate a predetermined overhead rate for each activity.
We have the following table that calculate the overhead rate of each activity:
Table 1: Calculation Table
Activity | Cost pool | Overhead cost | Cost driver activity | Overhead rate |
Interview client | Hour | 1,615,000 | 19,000 | 85 |
Obtain missing data | Return (business only) | 800,000 | 9,000 | 88.88889 |
Input data | Hour | 390,000 | 9,750 | 40 |
Verify return with client | Hour | 875,000 | 8,750 | 100 |
Rectify errors | Return (Phase 2) | 40,000 | 1,087 | 36.79853 |
Submit return | Return | 50,000 | 12,000 | 4.166667 |
License fee | Return (business only) | 25,000 | 9,000 | 2.777778 |
Business return extra | Return (business only) |
|
| 2.5 |
Step 5. Allocate overhead costs to products.
Total overhead cost for hour pool is 2,880,000. Cost driver activity for hour poll is 37,500
The overhead rate for hour pool is therefore 76.8.
The overhead for non-business return without error is 4.17
The total number of hours spent on each individual return is 1/3+/1/4+1/6 = 0.75 hour
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