Activity-Based Costing

Activity-Based Costing (ABC) is when you figure out the cost of activities to then discover the cost of products and services. ABC occurs in in four stages. These steps are as follows: identify activities and calculate their estimated total costs, identify the allocation base for each activity and estimate the total quantity of each allocation base, compute the predetermined overhead allocation rate for every activity, and allocate indirect costs to the cost object. I will use the production of a shirt to explain the process of ABC. Manufacturing a shirt requires three activities: setup, production, and shipping/packaging. In the setup stage, the machines are weaved with the proper thread, and oiled down, which allows the shirts to then be manufactured. After production, the shirts are packaged and shipped out. The estimated overhead cost for setup in the next year is $10,000 for setup, $25,000 for production, and $15,000 for packaging/shipping. In the next step, we give allocating bases to each. The allocation base for the setup stage is number of thread bobs used to produce 100 shirts, which is 10 thread bobs. The allocation base for production is the number of shirts that can be produced in an hour (500). The allocation base for
Prevention cost is incurred to avoid poor-quality goods and/or services and an example of this cost would be employee training. Appraisal cost is incurred to detect poor-quality materials, goods, or services. An example of appraisal cost is when a farmer inspects her or her harvest prior to sale. Internal failure cost is incurred when to company corrects poor-quality items prior to its delivery to customers, and an example of this is rejected products. External failure cost incurs when the company does not detect bad quality in their products until after delivery, and an example of this is lost sales due to unhappy