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Absorption Costing (AC) and Activity- Based Costing (ABC) for Inventory Freight | Transportation

Absorption Costing (AC) and Activity- Based Costing (ABC) for Inventory Freight | Transportation

Absorption costing is traditional costing method while Activity- Based Costing ( ABC) is modern costing method. Absorption costing is simple way and less time consuming for calculation, but Activity-Based Costing ( ABC) is complex way and more time consuming. Activity-Based Costing ( ABC) is more accurate than Absorption costing (AC).

In practice, we can use both methods. Small amount we may use Absorption costing (AC) while large amount we will use Activity-Based Costing ( ABC). How much small or large amount is based on your business nature and judgment.

Cost of inventory = purchase price – trade discount + transportation in + insurance cost + importation tax + specific tax ( if any) + handling cost + port cost + clearance cost + other relevant costs

In our example, we will use both methods ( AC and ABC) for allocating cost of transportation in ( freight in /delivery) to cost of inventory.




Example

We have total costs $2,000 for freight in (transportation in) of following inventory.

Goods  Units  Kg
 A            500         1,000
 B            200            600
 C            300            300
 Total         1,000         1,900

 

Assume that transportation cost is based on kilogram of inventory.

Required:

  1. Total cost of each inventory based Absorption Costing (AC)
  2. Total cost of each inventory based on Activity Based Costing (ABC)

Solution

  1. Total cost of each inventory based Absorption Costing (AC)

Transportation Absorption rate per unit = $2,000/1,000=$2/unit

Goods Transportation cost Calculation
A $1,000 500 x $2
B $400 200 x $2
C $600 300 x $2
$2,000
  1. Total cost of each inventory based on Activity Based Costing (ABC)
Goods Transportation cost($) Calculation
A                             $ 1,052.63 1,000/1,900 x $2,000
B                             $  631.58 600/1,900 x $2,000
C                             $  315.79 300/1,900 x $2,000
                               $ 2,000

So total cost of each inventory is different figure based on each method.

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