Explain cost flow in activity based costing, Managerial Accounting

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Cost flow in activity based costing

Activity basically fall into four different categories known as the manufacturing cost hierarchy. These categories are generally accepted today but were first identified by cooper(1990). The categories of activities help to determine the type of activity cost driver required.

 The categories of activities are:

1) Unit level activities: the costs of some activities (mainly primary activity) are strongly correlated to the number of unit  produced. For example the use of indirect materials consumables tends to increase in proportion to the number of units produced. Another example of a unit level activity is the inspection or testing of every item production, if this was deemed necessary or perhaps more likely every 100th item production.

2) Batch level activities : the cost of some activities (mainly manufacturing support activities) are driven by the number of batches of units production. Example of this are:

Material ordering –where an order is placed for every batch of production

Machine set-up costs-where machines need resetting between each different batch of production.

Inspection of products-where the first item in every batch is inspected rather than every 100th item quoted above.

3) Product level activities :the costs of few activities (often once only activities) are driven by the creation of a new product line and its maintenance for instance designing the product producing managers. Advertising campaigns that promote the category if individual products are advertised  rather than the company name.

4) facility level activities: some costs cannot be related to a particular product line instead they are related to maintaining the building and facilities. Example are the maintenance of building plant security business rate etc. also included in this category are salaries such as the production managers. Adverting campaigns that promote the organization would also be included.

 The first and last categories above are the same as those in traditional absorption costing and so if an organization costs are mainly made up of these two categories ABC will not improve the overhead analysis will provide a different and more accurate analysis.


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