Step 1 Identify different type of activities. The first important step to implementing the Activity based costing system is to analyses activity and then classified into different category which related to different part of the production process. Since the activity base costing system allocate overhead cost to product base on activity, therefore the cost driver needed to identify from each activity to allow tracing overhead cost to the product. Example for the activity of ordering of cloth, the cost driver will be the number of orders. Moreover the activities involve are classified into four categories "Batch level activity, Unit level activity, Product level activity and Facility level activity" (Periasamy, P. 522). Batch Level activity which is the activity made with every group of same product or unit is produced and the number of unit produce does not concern the number of batch level. Purchase order, equipment setup, Material Handling and Quality inspection which are also sample of batch level activity. In the other hand the unit level activity is counted with every unit or product are made. Machine hour, direct labor hour, direct material and calibration activity are the example of unit activity level which value changes as the unit produce increase or decrease. Next the product level activities which are counted when there are activities that support the diversity of product take place. Maintenance equipment, product sustaining, are the example for product level activity. Lastly which is the facility level activity, activity only counted when there are activities that support the factory manufacturer process take place. Example factory maintenance, plant depreciation, these activity take place once in a while to make sure the factory manufacture process running smoothly (Edmonds, Bor-Yi Tsay and Olds 208-211) .
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Step 2 Allocate overhead costs to activity. Second step is to allocate all the overhead cost into the activity cost pool and which is also the first stage allocation of the activity based costing system. However information is needed to assign overhead cost to the activity therefore interview of employees which involve in management is needed to determine resources and determine how the overhead cost in that category allocated to each different activity cost pool. Because of the employees have direct involves in the project therefore they have clearer picture how the overhead cost is consumed from the activity than everyone else. For example, the employees are interview how the wages and salaries overhead cost is distribute to the following activity cost pool: supporting direct labor, order processing and customer support. Once the interview the result data of resources consumption by activities is display in term of percentage into statistic or table, it is easy to allocate cost into the activity cost pool. The overhead cost is allocated by multiply percentage given in the result data of resources consumption table with the overhead cost of that category. For example, forty percent of wages and salaries overhead cost is allocated into the supporting direct labor therefore the total overhead cost of wages and salaries of $400,000 are multiply by 40%. In the result, $160,000 overhead cost from wages and salaries is allocated into the supporting direct labor. After allocate all the overhead cost to activity the total of each activity overhead cost is calculated and display into a data table (Garrison, Noreen and more 290).
Step 3 Calculate cost driver rate for activity. Third step of the activity based costing is to calculate the cost driver rate for each activity cost pool. Cost driver rate can be calculate by using the overhead cost of the particular activity cost pool divide by total activity of its cost driver which determine in step 1. Example the total overhead cost order processing is $40,000 and the number of the customer order is 400. The cost driver rate can be calculates by using $40,000 overhead cost divide by 400 order which is $100 per order. There things need to concern in this step 3 first which is the cost driver. Cost driver is important because cost driver are the activities that affect the total overhead cost of the specific activity cost pool changes. Therefore a correct cost driver for that particular activity cost pool need to be identify in step 1 to avoid error. More over which are the other cost, other cost pool are the only cost cannot be calculate the cost driver rate because it consist of other cost which does not allocated into product and customer.
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Step 4 Allocate overhead costs to product base on product demand for activity. The forth step in the activity base costing is assign overhead cost to the product base on the customer product demand. This step is also called the second stage allocation and this method calculate by using the cost driver rate of the specific activity cost pool that calculate in step 3 multiply by the volume of activity based on customer demand. Example the HaoLi Enterprises have order 20 unit of product X in a time from Ali Product Corporation. Each unit require 5 direct labor hour and the cost driver rate for support direct labor, order processing are $20 per direct labor hour, $500 per order. The total direct labor hour in support direct labor is 20 unit multiply by 5 direct labor per unit which is 100 direct labor. The overhead cost of support direct labor assign to products will be $20 per direct labor hour multiply by 100 direct labor hour which is $2000. For the overhead cost of order processing assign to product will be $500 per order multiply by 1 order which is $500 because the HaoLi Enterprises only make his order in one time. The overhead cost assign to different type of product and different type of customer may be different because it is bases on customer order for each product and different customer may have different requirement in the product.
Step 5 Prepare a project report. The final step of activity based costing is to prepare management report base on the data gather from step 1 to step 4. There are two type of management report which use in activity based costing which are the customer margin report and the product margin report. Both report help the companies get an idea where are the profit get from, which product of the company gain the highest profit and which customer is the best opportunities for the company. To make a product margin report first need to collect all the sales and direct cost data for each product. Next, gather the overhead cost data for each product that calculated in step 4 into the data. Final is to calculate the product margin by using total sales for each product minus the direct cost and overhead cost which is the total cost of each product. Moreover is to make a customer margin report by using HaoLi Enterprises as an example. First collect the sales data and direct cost for HaoLi Enterprises, then collect the overhead cost data that assign to HaoLi Enterprises. Lastly, calculate customer margin of HaoLi Enterprises by using sales minus total cost.