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activity-based costing focuses on identifying activities required to make a product, forming cost pools for each activity, and allocating overhead costs to products based on the products’ use of each activity. Rather than establishing one standard variable overhead rate and standard quantity based on one cost driver, activity-based costing establishes several standard variable overhead rates and quantities, each having its own cost driver.
Instead of allocating overheads on the basis of predetermined rate, Activity based costing allocates indirect Over Head Costs to different products on the basis of activity performed for a particular product using the activity drivers. This minimizes the allocation of only relevant cost to products.
For example : Maitenance of machine being used to produce different products is allocated to products on the basis of machine hours used for individual products
- Laundary cost is allocated to different products on the basis of numbers of workers working individual products.
- Depreciation of factory building is allocated on the basis of area square KM used by different production departments. and finally to products on the basis of machine hours. etc
