Stage I
In the first stage, major activities of a form for manufacturing finished products are required to be noted. Like material procurements, material handling, production runs, customers' order execution etc. needed by every product line.
Following are the few examples of the activities:
* Material procurement
* Customers' order execution
* Inspections
* Production scheduling
* Employee's related activity
* Material handling
* Dispatch of goods
* Machine operation
* Production runs
* Set-ups
Stage II
In the second stage, cost indicators, also called cost drivers, influence overheads needed to be listed in accordance with the major activities required by products. Nature of activity or transaction decides a suitable cost driver
Activity-based costing system uses an appropriate cost driver that differs with the nature of activities that create costs.
A few examples of the activities and appropriate cost drivers are stated below:
Activities or transactions...............Cost drivers
Material procurement.................................Number of materials procured
Material handling.........................................Quantity of input material
Customers' order execution........................Number of orders executed
Dispatch of goods..........................................Number of dispatches
Inspections.....................................................Number of inspections
Machine operation.........................................Machine hours
Production scheduling...................................Number of production scheduling
Production runs..............................................Number of production run
Employees' related activity...........................Number of employees
Set-ups.............................................................Number of set-ups
Stage III
Analysis and collection of cost incurred for each cost pool are essential for determining driver rate. A cost pool is like a center.
illustration:
If inspection cost is $ 140,000 for assembling 100 ordinary and 100 automatic cameras. If one ordinary camera needs 2 inspections and one automatic camera needs 5 inspection, then find the inspection cost per inspection.
Solution,
Calculation of number of inspection:
Number of inspections of ordinary cameras = 100 cameras x 2 = 200
Number of inspections of automatic camera = 100 cameras x 5 = 500
Therefore, total number of inspections = 200+500 = 700
Now, inspection cost per inspection = total inspection costs/No. of inspections
= $ 140000/700 inspections = $ 200 per inspection.
Stage IV
Trace or allocate the cost of the activities or operations to the final products.
Trace refers to the distribution of overheads to different product lines produced by using a cost driver rate. Overheads are recovered by different product lines based on the number of the activities required by each product by using a driver rate. Tracing refers to the recovery of inspection cost by the product lines by using relevant cost driver.
In the above illustration, $ 100000 and $ 40000 shared by automatic and ordinary cameras respectively i.e the ordinary camera required 200 inspection at the rate of $ 200 per inspection and automatic cameras required 500 inspection at the rate of $200 per inspection.
Thus, overheads are assigned to prevailing products lines by recognizing the relevant cost drivers for ascertaining product cost under activity-based costing.
