It shows that products will be charged $120 in overhead costs for each purchase requisition processed, $800 for each machine setup, $30 for each machine hour used, $6 for each direct labor hour worked, and $50 for each hour of inspection time.įigure 3.4 Predetermined Overhead Rates for SailRite Company Figure 3.4 "Predetermined Overhead Rates for SailRite Company" provides the overhead rate calculations for SailRite Company based on the information shown in the previous three steps. This is done by dividing the estimated overhead costs (from step 2) by the estimated level of cost driver activity (from step 3). Calculate a predetermined overhead rate for each activity. Notice that this information includes an estimate of the level of activity for each cost driver, which is needed to calculate a predetermined rate for each activity in step 4. The accountant at SailRite developed the following allocations after careful review of all overhead costs (remember, these are overhead costs, not direct materials or direct labor costs): For SailRite, the cost pool for the purchasing materials activity will include costs for items such as salaries of purchasing personnel, rent for purchasing department office space, and depreciation of purchasing office equipment. This step requires that overhead costs associated with each activity be assigned to the activity (i.e., a cost pool is formed for each activity). Assign overhead costs to the activities identified in step 1. The most challenging part of this step is narrowing down the activities to those that have the biggest impact on overhead costs.Īfter meeting with personnel throughout the company, SailRite’s accountant identified the following activities as having the biggest impact on overhead costs: Companies that use activity-based costing, such as Hewlett Packard and IBM, may identify hundreds of activities required to make their products. This requires interviewing and meeting with personnel throughout the organization. The goal is to understand all the activities required to make the company’s products. is any process or procedure that consumes overhead resources. Identify costly activities required to complete products.Īn activity Any process or procedure that consumes overhead resources. However, the total is broken out into different activities rather than departments, and an overhead rate is established for each activity. As you work through the example for SailRite Company, once again note that total estimated overhead costs remain at $8,000,000. ![]() Thus the cost of activities should be allocated to products based on the products’ use of the activities.įive steps are required to implement activity-based costing. (Remember that plantwide allocation uses one cost pool for the whole plant, and department allocation uses one cost pool for each department.) The idea is that activities are required to produce products-activities such as purchasing materials, setting up machinery, assembling products, and inspecting finished products. uses several cost pools, organized by activity, to allocate overhead costs. What are the five steps of activity-based costing, and how would this method work for SailRite?Īnswer: Activity-based costing (ABC) A method of costing that uses several cost pools, and therefore several predetermined overhead rates, organized by activity to allocate overhead costs. Question: Suppose the managers at SailRite Company decide that the benefits of implementing an activity-based costing system would exceed the cost, and thus the company should use activity-based costing to allocate overhead. ![]() ![]() ![]() Understand how to use the five steps of activity-based costing to determine product costs.
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