Activity Based Costing System

1. The Aeronautical Ltd. has production facility

specializing in jobs for aircraft components market. The
traditional costing system has 2 direct-cost categories,
namely direct materials and direct manufacturing
labour and a single direct cost pool, that is ,
manufacturing overhead allocated on the basis of
direct labour hours . The indirect cost allocation rate
would have been Rs. 115 , direct manufacturing labour
hour.
The company has now decided to replace the single
indirect cost pool with 5 indirect cost pools,
representing 5 activity areas each with its own
supervising and budget responsibility. The relevant
data are as follows:
Activity area Cost driver used as an Cost allocation
allocation base rate (in Rs.)
Material handling Parts 0.40

Lathe work Turns 0.20

Milling Machine hours 20.00

Grinding Parts 0.80

Testing Units tested 15.00

Two representative jobs processed under the new system of

facility at the most recent period had the following features:
Particulars Job 101 (in Rs.) Job 102 (in Rs.)
Direct materials cost per job 9,700 59,900
Direct manufacturing labour cost per job 750 11,250
Direct manufacturing labour hours per job 25 375
Parts per job 500 2,000
Turns per job 20,000 60,000
Machine hours per job 150 1,050
Units per job 10 200

Required:
1. Compute the per unit manufacturing costs of each job under
the traditional job-cutting system.
2. Compute the per unit manufacturing costs of each job under
the activity based costing system.
Solution:
a) Manufacturing costs with traditional job costing system.
Particulars Job 101 (in Rs.) Job 102 (in Rs.)
Direct manufacturing costs
per job
Direct materials per job 9700 59,900
Direct manufacturing labour 750 11,250
per job
10,450 71,150
Indirect manufacturing costs 25*115 375*115
per job
2875 43,125
Total costs per job 13,325 1,14,275
b) Manufacturing costs with activity based costing system.
Particulars Job 101 (in Rs.) Job 102 (in Rs.)
Direct manufacturing costs per job
Direct materials per job 9700 59,900
Direct manufacturing labour per job 750 11,250
a) Total 10,450 71,150
Indirect manufacturing costs per job
b) Material handing 500*.40 2000*.40
200 800
c) Lathe work 20,000*.20 60,000*.20
4000 12000
d) Milling 150*20 1050*20
3000 21,000
e) Grinding 500*.80 2000*.80
400 1600
f) Testing 10*15 200*15
150 3000
18,200 1,09,550
2. A company manufacturing 2 products furnishes the following
data for a year :

Product Annual output Total Total no. of Total no. of

(units) machine hrs. purchase set-ups
orders
A 5000 20,000 160 20
B 60,000 1,20,000 384 44

The annual overhead are as under:

Volume related activity costs Rs. 5,50,000
Set-up related costs 8,20,000
Purchase related costs 6,18,000

You are required to calculate the costs per unit of each product A & B
based on :
i) Traditional method of charging overheads
ii) Activity based costing method.
Solution
a) Statement showing costs per unit of product A&B based on
traditional method:

Total annual overheads (Rs. 5,50,000+ 8,20,000+ 6,18,000) 19,88,000

Total machine hrs. 1,40,000
Machine hr rate (Rs. 19,88,000/1,40,000 hrs.) 14.2

Particulars A B
Annual output (units) 5000 60,000
Total machine hrs. 20,000 1,20,000
Overhead cost Rs. 2,84,000* Rs. 17,04,000**
Overhead cost per unit Rs. 56.80 # Rs 28.40 ##

*(20,000 X Rs. 14.20) **(1,20,000 X Rs. 14.20)

#(Rs. 2,84,000/5,000 units) ##(Rs. 17,04,000/60,000 units)
b) Statement showing costs per unit of product A&B based on Activity
based costing method:
Machine hr rate (Rs. 5,50,000/1,40,000 hrs.) Rs. 3.93
Cost of one set up (Rs. 8,20,000/ 64 setups) 12,812.50
Cost of purchase order (Rs. 6,18,000/ 544 orders) 1,136.03

Particular A B
Total machine hrs. 20,000 1,20,000
Cost related to volume activities Rs. 78,600* 4,71,600**
Cost related to purchases Rs. 1,81, 764 # Rs.4,36,235.52 ##
Cost related to setups 2,56,250 @ Rs. 5,63,750 @@
Total costs 5,16,614.80 14,71,585.52
Annual output units (÷) 5000 (÷) 60,000
Cost per unit Rs. 103.32 Rs. 24.53

* (20,000 hrs X Rs. 3.93) ** (1,20,000 hrs X Rs. 3.93)

# (160 orders X Rs. 1,136.03) ## (384 orders X Rs. 1,136.03)
@ (20 setups X Rs. 12,812.50) @@(44 setups X Rs. 12,812.50)
3. Bright light ltd. manufactures 2 products: bright and delight, using
the same equipment and similar process. The following information
is extracted from the production deptt. Pertaining to the 2 products
for the quarter ending 31 Dec, 2007:
Particulars Bright Delight
Qty produced (units) 10,000 15,000
Direct labor hrs per unit 2 4
Machine hrs per unit 3 1
No. of setups in the prd. 20 80
No. of orders handled in the prd. 30 120

Total productions overheads recovered for the prd. has been analysed as
follows:
Particulars Rs.
Relating to machine activity 4,50,000
Relating to production run setups 40,000
Relating to handling orders 90,000
5,80,000
Calculate the production overheads to be absorbed by each unit of the
products using the following costing methods:
a) A traditional costing approach, using direct labour hr. rate to
absorb overheads.
b) An ABC approach, using suitable cost drivers to trace overheads to
products.
Solution
a) Traditional costing
Direct labor hrs (DLH)
Bright (10,000units*2 hrs.) 20,000 hrs.
Delight (15,000 units* 4 hrs.) 60,000 hrs.
80,000 hrs
So, Overhead absorption rate = Rs. 5,80,000/80,000 hrs = Rs. 7.25
Overhead absorbed would be as follows:
Bright (2 hrs * Rs. 7.25) = Rs. 14.25 per unit
Delight (4 hrs. * Rs. 7.25) = Rs. 29 per unit
b) Activity based costing (ABC)
Machine hrs (MH)
Bright (10,000units* 3 hrs.) 30,000 hrs.
Delight (15,000 units* 1 hr.) 15,000 hrs.
45,000 hrs

Using ABC, the overhead costs are absorbed according to the cost
drivers:
MH driven costs Rs. 4,50,000/45,000 MH = Rs. 10 per MH
Setup driven costs Rs. 40,000/100 = Rs. 400 per set up
Order driven costs Rs. 90,000/150 Rs. 600 per order
Particulars Bright (Rs.) Delight (Rs.)
Machine driven costs 30,000 hrs* Rs. 10 15,000 hrs*Rs. 10
3,00,000 1,50,000
Setup costs 20 * Rs.400 80 * Rs. 400
8000 32,000
Order handling costs 30 * Rs.600 120 * Rs.600
18,000 72,000
Total costs 3,26,000 2,54,000
Units produced 10,000 15,000
Overhead costs per unit Rs. 32.60 Rs. 16.93

Overhead costs
4. Modern India ltd. manufactures three products under the same
production processes and equipments. A conventional product costing
system is used at present, although an ABC system is being considered.
The company has furnished the following information relating to the 3
products during the Yr. 2007-08:

Products Production Material cost Labour hrs Machine hrs.

units per unit per unit per unit
A 500 Rs. 80 0.5 0.75
B 800 Rs. 70 1 1.5
C 1200 Rs. 60 1.25 2
Direct labour cost of the company is Rs. 60 per hr. According to the
conventional method, the company absorbs production overheads on
machine hr. basis. The rate for the period is Rs. 30 per machine hr.
The production overhead costs for different activities are given below on
the basis of percentage.
Activities %
Setups 20
Materials handling 20
Machinery 30
Inspection 30
Total production activities 100

The volumes of activities associated with the products are given below:

Activities A B C
No. of setups 18 12 20
No. of movements of materials 20 25 30
No. of inspection 15 12 18

Calculate the cost per unit for each product using ABC method.
Solution:
ABC method:
Total production overhead costs based on machine hours’ weightage
A 500 units * 0.75 hr. 375 hrs
B 800 units *1.5 hr. 1200 hrs
C 1200 units * 2 hrs 2400 hrs
Total 3975 hrs

Production overhead cost = 3975 hrs * Rs 30 = Rs. 1,19,250

Cost of Activities % In Rs.
Setups 20 23,850
Materials handling 20 23,850
Machinery 30 35,775
Inspection 30 35,775
Total production activities 1,19,250
 Allocation of activity-wise costs among products
Activities Total (Rs.) A (Rs.) B (Rs.) C (Rs.)
Setups (18:12:20) 23,850 8586 5724 9540
Materials handling 23,850 6360 7950 9540
(20:25:30)
Machinery 35,775 3375 10,800 21,600
(375:1200: 2400)
Inspection (15:12:28) 35,775 11,925 9540 14,310
Total 1,19,250 30,246 34,014 54,990
No. of units 500 800 1200
Production overheads
cost per unit (rounded
60.00 43.00 46.00
off)
 Calculation of costs per product
Product cost per unit A B C
Materials 80 70 60
Labour 0.5* Rs 60 1 * Rs 60 1.25 * Rs 60
30 60 75
Production overheads 60 43 46
Total 170 173 181
4. Modern India ltd. manufactures three products under the same
production processes and equipments. A conventional product
costing system is used at present, although an ABC system is being
considered. The company has furnished the following information
relating to the 3 products during the Yr. 2007-08: