Compare assigned costs per product under both methods. Why has Activity-based costing changed the total costs assigned to each product?
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By comparing the two cost assigned methods, there are some differences existed: Unit Product Cost:| Gadgets| Smidgets| Smadgets| Smadgets| Traditional Costing Method| 400| 1,000| 1,350| 850|
Activity-Based Costing Method| 590| 1,100| 760| 1,250|
Overhead Cost| Widgets| Gadgets| Smidgets| Smadgets|
Traditional Costing Method| 200,000| 600,000| 800,000| 400,000| Activity-Based Costing Method| 390,000| 600,000| 210,000| 800,000|
I deduct the main reason for that are:
Traditional Costing Method use the Overhead Rate (200% of direct labor) and the Activity-Base Costing Method just use the Overhead Cost Drives.
As for Traditional Costing Method, the company just accumulate costs into a cost center (Three kinds of costs: director material, director labor, Manufacturing Overhead) , and the Manufacturing overhead just equals the director labor multiply by 200% , the Overhead Rate. These three kind of costs added together we got the total cost, and the total cost divided by the each unit built, we get the final unit product cost, I think it is a rough calculating process. The result depends on the direct labor hours and regardless of any other elements, if direct labor dose not account for a larger portion of the product, the result will not be accurate.
In terms of Activity-based costing method, the company use Overhead Cost Drives (There are three allocation bases in the ABC method: depreciation, machine set-up and rent). The Overhead expense just use cost drivers (Such as Machine hours, Set-up hours and Rent) to apply the costs on the products. On the basis of these three, we can get the Overhead cost drive’s Pool Rate, and we also get the actual Cost Driver Quantity for Product Line, and finally we can know what is the exact Activity Cost for Product Line with respect products, finally, we got the total ABC Overhead cost for the
three products. So I think this allocating process is more accurate, because it use the Cost drives into different part in detail.