CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

CHAPTER 4
ACTIVITY-BASED COSTING (ABC)
Activity-based costing (ABC)
Is a costing methodology that identifies activities in an organization and assigns the cost of each activity
with resources to all products and services according to the actual consumption by each. This model
assigns more indirect costs (overhead) into direct costs compared to conventional costing.

CIMA (Chartered Institute of Management Accountants) defines ABC as an approach to the costing and
monitoring of activities which involves tracing resource consumption and costing final outputs. Resources
are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize
cost drivers to attach activity costs to outputs.
Aims of model:

Traditionally, cost accountants had arbitrarily added a broad percentage of analysis into the indirect cost.
In addition, activities include actions that are performed both by people and machine. However, as the
percentages of indirect or overhead costs rose, this technique became increasingly inaccurate, because
indirect costs were not caused equally by all products.

Identification of appropriate cost drivers under ABC:

Cost driver:
According to CIMA, ‘cost driver
- is any factor which causes a change in the cost of ssan activity. A cost driver is the unit of an activity
that causes the change in activity's cost.
"Cost drivers are the structural determinants of the cost of an activity, reflecting any linkages or
interrelationships that affect it" (M. Porter).

Examples of cost driver:

1.In marketing, cost drivers are Number of advertisements,
Number of sales personnel etc.
2.In Customer service, cost drivers are Number of service calls attended
number of staff in service department,
number of warranties handled,
Hours spent on servicing etc...

In activity based costing method, to identify cost drivers is very necessary for unit cost and total cost.
We know that activity-based costing is based on the concept that products consume activities and
activities consume resources. From activity pools, we can find cost drivers. Suppose, a company wants
to produce several products at that time, what will company do for calculating per unit cost? Just adding
of raw material and labor cost and absorbing production overheads on direct labour hours or machine
hours is not good way. There will be many activities where we have to spent money.

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All these activities will become cost drivers. Examples of these cost drivers are given below

1. No. of Purchase Orders:

When we have to make any product, we issue the order. This is a simple activity. Its cost can be
calculated one the basis of no. of purchase orders. So, number of purchase order is an example of cost
driver.

2. No. of Set up of Machine:

Setting up the machine is an activity of production. This activity will also consume certain expenses. To
know machine set up rate, we need a cost driver. No. of set up will be cost driver. With this, we can
calculate set up of machine overhead rate per set up of the machine for production.

3 No. of Machine Hours:

No. of Machine hours is different cost driver which can be used for calculating machine hour rate relating
to depreciation, repair and maintenance of machines.

4. No. of Parts or Weight of Material Handled:

Suppose, a company is making 4 products These 4 products need 16 parts to assemble with each other.
Different expenses may be spent for this activity. We can calculate rate of this overhead on the basis of
no. of parts. So, number of parts is a cost driver.

5. No. of Test or No. of Inspections:

When any product is made, it is test for checking its quality. Specific experts are appointed for this. They
consume money in the form of salary, electricity, travel and other depreciation of their specific
equipments. Now, we need to calculate rate of these types of overheads. It can be calculated on the basis
of no. of test. So, number of test is cost driver. Suppose, we need 5 test per unit of a product and suppose
we have made 1000 units. It means, we need 5000 tests for these units. If the accounts of inspection and
test departments show the total cost Rs. 1,000,000. We can calculate rate of per unit test.

= 1,000,000 / 5000 = Rs. 20 per unit test

6. No. of Direct Labour Hours:

No. of direct labour hours is that cost driver which can be used for calculating supervising cost per unit.

8. No. of Batches of Material

For calculating, storage cost per batch, we have to make a cost driver that will be no. of batches of
material.

9. No. of Machine Operators:

No. of machine operators is better cost driver for calculating electricity rate per machineoperation.

Above are just examples of cost drivers which are used but you can also different cost drivers which may
be appropriate for calculating overhead cost of products under ABC method.

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Activity-based costing is best explained by walking through its various steps. They are:
1.Identify costs.
The first step in ABC is to identify those costs that we want to allocate. This is the most critical step in the
entire process, since we do not want to waste time with an excessively broad project scope. For example,
if we want to determine the full cost of a distribution channel, we will identify advertising and
warehousing costs related to that channel, but will ignore research costs, since they are related to
products, not channels.
2.Load secondary cost pools.
Create cost pools for those costs incurred to provide services to other parts of the company, rather than
directly supporting a company’s products or services. The contents of secondary cost pools typically
include computer services and administrative salaries, and similar costs. These costs are later allocated to
other cost pools that more directly relate to products and services. There may be several of these
secondary cost pools, depending upon the nature of the costs and how they will be allocated.
2.Load primary cost pools.
Create a set of cost pools for those costs more closely aligned with the production of goods or services. It
is very common to have separate cost pools for each product line, since costs tend to occur at this level.
Such costs can include research and development, advertising, procurement, and distribution. Similarly,
you might consider creating cost pools for each distribution channel, or for each facility. If production
batches are of greatly varying lengths, then consider creating cost pools at the batch level, so that you can
adequately assign costs based on batch size.
3.Measure activity drivers.
Use a data collection system to collect information about the activity drivers that are used to allocate the
costs in secondary cost pools to primary cost pools, as well as to allocate the costs in primary cost pools
to cost objects. It can be expensive to accumulate activity driver information, so use activity drivers for
which information is already being collected, where possible.
4.Allocate costs in secondary pools to primary pools.
Use activity drivers to apportion the costs in the secondary cost pools to the primary cost pools.
5.Charge costs to cost objects.
Use an activity driver to allocate the contents of each primary cost pool to cost objects. There will be a
separate activity driver for each cost pool. To allocate the costs, divide the total cost in each cost pool by
the total amount of activity in the activity driver, to establish the cost per unit of activity. Then allocate
the cost per unit to the cost objects, based on their use of the activity driver.
6.Formulate reports.
Convert the results of the ABC system into reports for management consumption. For example, if the
system was originally designed to accumulate overhead information by geographical sales region, then
report on revenues earned in each region, all direct costs, and the overhead derived from the ABC system.
This gives management a full cost view of the results generated by each region.
7.Act on the information.
The most common management reaction to an ABC report is to reduce the quantity of activity drivers
used by each cost object. Doing so should reduce the amount of overhead cost being used.
We have now arrived at a complete ABC allocation of overhead costs to those cost objects that deserve to
be charged with overhead costs. By doing so, managers can see which activity drivers need to be reduced
in order to shrink a corresponding amount of overhead cost. For example, if the cost of a single purchase
order is $100, managers can focus on letting the production system automatically place purchase orders,
or on using procurement cards as a way to avoid purchase orders. Either solution results in fewer purchase
orders and therefore lower purchasing department costs.

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Uses of activity based costing:

The fundamental advantage of using an ABC system is to more precisely determine how overhead is
used. Once you have an ABC system, you can obtain better information about the following issues:

1.Activity costs.
ABC is designed to track the cost of activities, so you can use it to see if activity costs are in line with
industry standards. If not, ABC is an excellent feedback tool for measuring the ongoing cost of specific
services as management focuses on cost reduction.
2.Customer profitability.
Though most of the costs incurred for individual customers are simply product costs, there is also an
overhead component, such as unusually high customer service levels, product return handling, and
cooperative marketing agreements. An ABC system can sort through these additional overhead costs and
help you determine which customers are actually earning you a reasonable profit. This analysis may result
in some unprofitable customers being turned away, or more emphasis being placed on those customers
who are earning the company its largest profits.
3.Distribution cost.
The typical company uses a variety of distribution channels to sell its products, such as retail, Internet,
distributors, and mail order catalogs. Most of the structural cost of maintaining a distribution channel is
overhead, so if you can make a reasonable determination of which distribution channels are using
overhead, you can make decisions to alter how distribution channels are used, or even to drop
unprofitable channels.
4.Make or buy.
ABC provides a comprehensive view of every cost associated with the in-house manufacture of a product;
so that you can see precisely which costs will be eliminated if an item is outsourced, versus which costs
will remain.
4.Margins.
With proper overhead allocation from an ABC system, you can determine the margins of various
products, product lines, and entire subsidiaries. This can be quite useful for determining where to position
company resources to earn the largest margins.
5.Minimum price.
Product pricing is really based on the price that the market will bear, but the marketing manager should
know what the cost of the product is, in order to avoid selling a product that will lose company money on
every sale. ABC is very good for determining which overhead costs should be included in this minimum
cost, depending upon the circumstances under which products are being sold.
6.Production facility cost.
It is usually quite easy to segregate overhead costs at the plant-wide level, so you can compare the costs
of production between different facilities.
Clearly, there are many valuable uses for the information provided by an ABC system. However, this
information will only be available if you design the system to provide the specific set of data needed for
each decision. If you install a generic ABC system and then use it for the above decisions, you may find
that it does not provide the information that you need. Ultimately, the design of the system is determined
by a cost-benefit analysis of which decisions you want it to assist with, and whether the cost of the system
is worth the benefit of the resulting information.

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Problems with activity based costing:

Many companies initiate ABC projects with the best of intentions, only to see a very high proportion of
the projects either fail, or eventually lapse into disuse. There are several reasons for these issues, which
are:

1.Cost pool volume.

The advantage of an ABC system is the high quality of information that it produces, but this comes at the
cost of using a large number of cost pools – and the more cost pools there are, the greater the cost of
managing the system. To reduce this cost, run an ongoing analysis of the cost to maintain each cost pool,
in comparison to the utility of the resulting information. Doing so should keep the number of cost pools
down to manageable proportions.
2.Installation time.
ABC systems are notoriously difficult to install, with multi-year installations being the norm when a
company attempts to install it across all product lines and facilities. For such comprehensive installations,
it is difficult to maintain a high level of management and budgetary support as the months roll by without
installation being completed. Success rates are much higher for smaller, more targeted ABC installations.
3.Multi-department data sources.
An ABC system may require data input from multiple departments and each of those departments may
have greater priorities than the ABC system. Thus, the larger the number of departments involved in the
system, the greater the risk that data inputs will fail over time. This problem can be avoided by designing
the system to only need information from the most supportive managers.
4.Project basis.
Many ABC projects are authorized on a project basis, so that information is only collected once; the
information is useful for a company’s current operational situation, and it gradually declines in usefulness
as the operational structure gradually changes over time. Management may not authorize funding for
additional ABC projects later on, so ABC tends to be “done” once and then discarded. To mitigate this
issue, build as much of the ABC data collection structure into the existing accounting system, so that the
cost of these projects is reduced; at a lower cost, it is more likely that additional ABC projects will be
authorized in the future.
5.Reporting of unused time.
When a company asks its employees to report on the time spent on various activities, they have a strong
tendency to make sure that the reported amounts equal 100% of their time. However, there is a large
amount of slack time in anyone’s work day that may involve breaks, administrative meetings, playing
games on the Internet, and so forth. Employees usually mask these activities by apportioning more time to
other activities. These inflated numbers represent misallocations of costs in the ABC system, sometimes
by quite substantial amounts.
6.Separate data set.
An ABC system rarely can be constructed to pull all of the information it needs directly from the general
ledger. Instead, it requires a separate database that pulls in information from several sources, only one of
which is existing general ledger accounts. It can be quite difficult to maintain this extra database, since it
calls for significant extra staff time for which there may not be an adequate budget. The best work-around
is to design the system to require the minimum amount of additional information other than that which is
already available in the general ledger.
7.Targeted usage.
The benefits of ABC are most apparent when cost accounting information is difficult to discern, due to
the presence of multiple product lines, machines being used for the production of many products,
numerous machine setups, and so forth – in other words, in complex production environments. If a
company does not operate in such an environment, then it may spend a great deal of money on an ABC
installation, only to find that the resulting information is not overly valuable.

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Comparison between ABC and traditional methods of overhead absorption based on production
units, labour hours or machine:

Costing systems helps companies determine the cost of a product related to the revenue it generates. Two
common costing systems used in business are traditional costing and activity-based costing.
Traditional costing assigns manufacturing overhead based on the volume of a cost driver, such as the
amount of direct labor hours needed to produce an item. A cost driver is a factor that causes cost to incur,
such as machine hours, direct labor hours and direct material hours. Activity-based costing allocates the
costs of manufacturing a product according to the activities needed to produce the item. Managers should
understand the advantages and disadvantages of both systems to meet the needs of their business.
Understanding Traditional Costing:
 Many manufacturing companies use the traditional costing system to assign manufacturing
overhead to units produced.
 Users of the traditional costing method make the assumption that the volume metric is the
underlying driver of manufacturing overhead cost.
 Under traditional costing, accountants assign manufacturing costs only to products. Traditional
accounting fails to allocate nonmanufacturing costs that also are associated with the production of
an item, such as administrative expenses.
 Companies commonly use traditional accounting in external financial reports because it provides
a value for the cost of goods sold.
Pros and Cons of Traditional Costing:
Advantages of Traditional Costing:
 An advantage of using traditional-based costing is that it aligns with Generally Accepted
Accounting Principles, or GAAP.
 Easy implementation for companies that provide one product also is a plus.
Disadvantages of Traditional Costing:
 However, traditional costing is an outdated costing system in many companies because those
manufacturing companies now use machines and computers for much of their production.
Computers and machines make the system outdated because it often uses direct labor hours to
calculate cost. Cost is not appropriately assigned because direct labor hours are not the best cost
driver to use.
 Traditional costing negates other cost drivers that may contribute to the cost of an item. Another
disadvantage of solely using the traditional costing system is that it can lead to bad management
decisions because it excludes certain nonmanufacturing costs.

Understanding Activity-Based Costing:

 Activity-based costing provides a more accurate view of product cost, but companies typically
use it as a supplemental costing system.
 The allocation bases used in activity-based costing differ from those used in traditional costing.
Activity-based costing determines every activity associated with producing an item and allocates
a cost to the activity.
 The cost assigned to the activity is then assigned to products that require the activity for
production.

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Pros and Cons of Activity-Based Costing:

Advantages of Traditional Costing:
 Greater costing accuracy is the primary benefit of activity-based costing. Companies assign cost
only to the products that require the activity for production.
 This method eliminates allocating irrelevant costs to a product.
 Other advantages of activity-based costing include an easy interpretation of cost for internal
management, the ability to enable benchmarking and a greater understanding of overhead costs.
Disadvantages of Traditional Costing:

 Implementing an activity-based costing system within a company requires substantial resources.

This can prove a disadvantage for companies with limited funds.
 Another disadvantage of using activity-based costing is that it is easily misinterpreted by some
users.

REVIEW QUESTIONS NBAA,ACCA,CIMA-

ADOPTED
QUESTION.1
NBAA NOVEMBER 2007
Dodo Ltd manufactures three products A, B and C Data for the period just ended is as follows:
Products A B C
Output in units 20,000 25,000 2,000
Tshs/Unit Tshs/Unit Tshs/Unit
Direct material cost 5,000 10,000 10,000
Total production overheads Tshs 190m
Information for overhead absorption on a labour hour’s basis
A B C
Labour hours/Unit 2 1 1
Labour is paid at the rate of Tshs. 5,000 per hour -
Information for activity based costing
Cost data Tshs. “000”
Machining 55,000
Quality control & set up costs 90,000
Receiving 30,000
Packing 15,000
190,000
Cost driver data A `B C
Machine hours/unit 2 2 2
No. of production runs 10 13 2
No. of components receipts 10 10 2
No. of customer orders 20 20 20
REQUIRED:
Calculate the total cost per unit for each product using:
a) Traditional absorption costing assuming production overheads are absorbed on the basis of
labour hours.
b) Activity based costing

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QUESTION.2
ACCA JUNE 2008
Jola Publishing Co publishes two forms of book. The company publishes a children’s book (CB), which
is sold in large quantities to government controlled schools. The book is produced in only four large
production runs but goes through frequent government inspections and quality assurance checks. The
paper used is strong, designed to resist the damage that can be caused by the young children it is produced
for. The book has only a few words and relies on pictures to convey meaning. The second book is a
comprehensive technical journal (TJ). It is produced in monthly production runs, 12 times a year. The
paper used is of relatively poor quality and is not subject to any governmental controls and consequently
only a small number of inspections are carried out. The TJ uses far more machine hours than the CB in its
production.
The directors are concerned about the performance of the two books and are wondering what the impact
would be of a switch to an activity based costing (ABC) approach to accounting for overheads. They
currently use absorption costing, based on machine hours for all overhead calculations. They have
accurately produced an analysis for the accounting year just completed as follows:

CB TJ
$per unit $per unit $per unit $per unit
Direct production costs
Paper 0·75 0·08
Printing ink 1·45 4·47
Machine costs 1·15 1·95
3·35 6·50
Overheads 2·30 3·95
Total cost 5·65 10·45
Selling price 9·05 13·85
Margin 3·40 3·40
The main overheads involved are:
Overhead % of total overhead Activity driver
Property costs 75·0% Machine hours
Quality control 23·0% Numberof inspections
Production set up costs 2·0% Number of set ups
If the overheads above were re-allocated under ABC principles then the results would be that the
overhead allocation to CB would be $0·05 higher and the overhead allocated to TJ would be $0·30 lower
than previously.
Required:
(a) Explain why the overhead allocations have changed in the way indicated above.

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(b) Briefly explain the implementation problems often experienced when ABC is first introduced.
The directors are keen to introduce ABC for the coming year and have provided the following cost and
selling price data:
1. The paper used costs $2 per kg for a CB but the TJ paper costs only $1 per kg. The CB uses 400g of
paper for each book, four times as much as the TJ uses.
2. Printing ink costs $30 per litre. The CB uses one third of the printing ink of the larger TJ. The TJ uses
150ml of printing ink per book.
3. The CB needs six minutes of machine time to produce each book, whereas the TJ needs 10 minutes per
book.
The machines cost $12 per hour to run.
4. The sales prices are to be $9·30 for the CB and $14·00 for the TJ
As mentioned above there are three main overheads, the data for these are:
Overhead Annual cost for the coming year
$
Property costs 2,160,000
Quality control 668,000
Production set up costs 52,000
––––––––––
Total 2,880,000
––––––––––
The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20 times.
Jola Publishing will produce its annual output of 1,000,000 CBs in four production runs and
approximately 10,000 TJs per month in each of 12 production runs.
Required:
(c) Calculate the cost per unit and the margin for the CB and the TJ using machine hours to absorb
the overheads.
(d) Calculate the cost per unit and the margin for the CB and the TJ using activity based costing
principles to absorb the overheads.

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QUESTION.3
ACCA JUNE 2010
Brick by Brick (BBB) is a building business that provides a range of building services to the public.
Recently they have been asked to quote for garage conversions (GC) and extensions to properties (EX)
and have found that they are winning fewer GC contracts than expected.
BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently absorbed on a
labour hour basis. BBB thinks that a switch to activity based costing (ABC) to absorb overheads would
reduce the cost associated to GC and hence make them more competitive.
You are provided with the following data:
Overhead Annual Activity driver Total number
Category overheads $ of activities per year
Supervisors 90,000 Site visits 500
Planners 70,000 Planning documents 250
Property related 240,000 Labour hours 40,000
––––––––
Total 400,000
––––––––
A typical GC costs $3,500 in materials and takes 300 labour hours to complete. A GC requires only one
site visit by a supervisor and needs only one planning document to be raised. The typical EX costs $8,000
in materials and takes 500 hours to complete. An EX requires six site visits and five planning documents.
In all cases labour is paid $15 per hour.
Required:
(a) Calculate the cost and quoted price of a GC and of an EX using labour hours to absorb the
overheads.
(b) Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the
overheads.
(c) Assuming that the cost of a GC falls by nearly 7% and the price of an EX rises by about 2% as
a result of the change to ABC, suggest possible pricing strategies for the two products that BBB
sells and suggest two reasons other than high prices for the current poor sales of the GC.
(d) One BBB manager has suggested that only marginal cost should be included in budget cost
calculations as this would avoid the need for arbitrary overhead allocations to products. Briefly
discuss this point of view and comment on the implication for the amount of mark-up that would be
applied to budget costs when producing quotes for jobs.

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QUESTION.4
ACCA DEC 2010
The Gadget Co produces three products, A, B and C, all made from the same material. Until now, it has
used traditional absorption costing to allocate overheads to its products. The company is now considering
an activity based costing system in the hope that it will improve profitability. Information for the three
products for the last year is as follows:
A B C
Production and sales volumes (units) 15,000 12,000 18,000
Selling price per unit $7.50 $12 $13
Raw material usage (kg) per unit 2 3 4
Direct labour hours per unit 0·1 0·15 0·2
Machine hours per unit 0·5 0·7 0·9
Number of production runs per annum 16 12 8
Number of purchase orders per annum 24 28 42
Number of deliveries to retailers per annum 48 30 62
The price for raw materials remained constant throughout the year at $1·20 per kg. Similarly, the direct
labour cost for the whole workforce was $14·80 per hour. The annual overhead costs were as follows:
$
Machine set up costs 26,550
Machine running costs 66,400
Procurement costs 48,000
Delivery costs 54,320
Required:
(a) Calculate the full cost per unit for products A, B and C under traditional absorption costing,
using direct labour hours as the basis for apportionment.
(b) Calculate the full cost per unit of each product using activity based costing.
(c) Using your calculation from (a) and (b) above, explain how activity based costing may help The
Gadget Co improve the profitability of each product.

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QUESTION.5
Duff Co manufactures three products, X, Y and Z. Demand for products X and Y is relatively elastic
whilst demand for product Z is relatively inelastic. Each product uses the same materials and the same
type of direct labour but in different quantities. For many years, the company has been using full
absorption costing and absorbing overheads on the basis of direct labour hours. Selling prices are then
determined using cost plus pricing. This is common within this industry, with most competitors applying
a standard mark-up.
Budgeted production and sales volumes for X, Y and Z for the next year are 20,000 units, 16,000 units
and 22,000 units respectively.
The budgeted direct costs of the three products are shown below:
Product X Y Z
$ per unit $ per unit $ per unit
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
In the next year, Duff Co also expects to incur indirect production costs of $1,377,400, which are
analysed as follows:
Cost pools $ Cost drivers
Machine set up costs 280,000 Number of batches
Material ordering costs 316,000 Number of purchase orders
Machine running costs 420,000 Number of machine hours
General facility costs 361,400 Number of machine hours
––––––––––
1,377,400
––––––––––
The following additional data relate to each product:
Product X Y Z
Batch size (units) 500 800 400
No of purchase orders per batch 4 5 4
Machine hours per unit 1·5 1·25 1·4
Duff Co wants to boost sales revenue in order to increase profits but its capacity to do this is limited
because of its use of cost plus pricing and the application of the standard mark-up. The finance director
has suggested using activity based costing (ABC) instead of full absorption costing, since this will alter
the cost of the products and may therefore enable a different price to be charged.
Required:
(a) Calculate the budgeted full production cost per unit of each product using Duff Co’s current
method of absorption costing. All workings should be to two decimal places.(3 marks)
(b) Calculate the budgeted full production cost per unit of each product using activity based
costing. All workings should be to two decimal places. (11 marks)
(c) Discuss the impact on the selling prices and the sales volumes OF EACH PRODUCT which a
change to activity based costing would be expected to bring about.

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Question.6
NBAA Adopted
(a ) Having attended a CPE programmer conducted by the NBAA on Activity Based Costing ( ABC )
you decided to experiment by applying the principle of ABC to the products currently being produce and
sold by your company. Details of the products and relevant information are given below for one period.

Product A B C D
Output in unit 120 100 80 120
Cost per unit Shs ‘000’ Shs. ‘000’ Shs. ‘000’ Shs. ‘000’
Direct material 40 50 30 60
Direct labour 28 21 14 21
Machine hour ( per unit 04 03 02 03
The four products are similar and are usually production runs of 20 units and sold in batches of 10 units
The production overheads are currently absorbed by using a machine hour rate and the total of the
production overhead for the period has been analysis as follows:
Shs.
Machine department costs ( rent business rate, department and supervision 10,430,000
Set costs 5,250,000
Stores receiving 3,600,000
Inspection / quantity control 2,100,000
Material handing and dispatch 4,620,000

You have ascertained that the ‘cost drivers to be used are as listen below for the overhead costs shown:
Overhead Cost Cost Driver
Set up costs Number of production run
Store receiving requisitions raised
Inspection / quality control Number of production runs
Material handing and dispatch Orders executed

The number of requisitions raised on the stores was 20 for each product the number of orders executed
was 42, each order being for a batch of 10 a product.
Required:
(a) Calculate the cost of the each product if all overhead cost are absorbed on
a machine hour basic.
(b ) Calculate the total cost for each product, using activity based costing
( c) Calculate and list the unit product cost from your figures in (i) above , to
show the difference and to comment briefly implications. (4 marks )
(d) (i)What do you understand by the term “through put accounting”
(ii) Contribution in its traditional from ( Sale-Variable costs because capacity
factors and the rate of production are ignored.

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

Question .7 ( ACCA Adopted )

The following information provides details of the volume and cost drivers for a particular period in
respect of ABC Company Limited.
Product X Product Y Product Z Total
Production/ sales in unit 30,000 20,000 8,000
Raw materials usage in units 5 5 11
Direct materials cost in Tshs. 25 20 11 1,238,000
Direct labor hours 1 1/3 2 1 88,000
Direct labor cost in Tshs 8 12 6
No of production run 3 7 20 30
Machine hours 1 1/3 1 2 76,000
No of orders delivers 9 3 20 32
No of receipts( order received ) 15 35 220 270
No of production order 15 10 25 50
Total overhead cost is allocated in the following objects
Set cost 30,000
Machine cost 760,000
Receiving cost 435,000
Packing cost 250,000
Engineering cost 373,000
Total 1,848,000
It the past the company has allocated overheads to products on the basis of direct labour hours. However ,
the majority of overheads are closely related to machine hours than direct labour hours.
The company has recently redesigned it cost system by recovering overheads using two volume related
bases machine hours and materials handing overheads rate for recovering overheads of receiving
department . Both the current and previous cost system reported low profit margins for product X, which
is the is the company’s highest selling product. The management accountant has recently attended the
conference on activity based costing, and overheads cost for the period has been analyzed by the major
activities in order to compute activity-bases costs.
From the above information you are require to
(a)Compute the product cost using a traditional volume related costing system
based on the assumption that:
(i)All overheads are recovered of direct labour ( i.e the company’s past
product costing system
(ii) The overheads of the receiving department are recovered are material
handing overhead rate and the remaining overheads are recovered using a
machine hours rate( i.e the company’s current costing system
( b)Compute product cost using an activity based costing system
(c )Briefly explain the differ and (b ) rences between the product cost
computation in (a)

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

Question.8 ( ACCA Adapted )

ABC Ltd manufactures four products namely A , B , C , and D using the same plant and process . The
following information related to a production period:
Product Volume Material cost direct labor per Machine time Labor cost per
per unit US$ unit per unit unit US$
A 500 5 0.5 0.25 3
B 5,000 5 0.5 0.25 3
C 600 16 2 1 12
D 7,000 17 1.5 1.5 9

Total overhead recorded by the accounting system is analyzed under the following headings
Factory overhead recorded applicable to machine – oriented activity
US $
Set up costs 37,424
The cost of ordering materials 1,920
Handing materials 7,580
Administration for spare parts 8,600
These overheads costs are absorbed by products on a machine hours of US$ 4.8 per hour giving an
overhead cost per product of
A = US$ 1.2 B = US$1.2 C = US$ 4.8 D = US$7.2
However investigation into the production overheads activities for the period for the reveals the following
total
Product No of set up No of Material order No of times material No of spare parts
was handled
A 1 1 2 2
B 6 4 10 5
C 2 1 3 1
D 8 4 12 4

You are require

(a) To compute an overhead cost per product using ABC tracing overhead to product units by
means of cost driver.
(b) To comment briefly on the differences disclosed between overheads traced by the present
system and those traced by activity based costing.

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

Question.9 ( NBAA Adapted ) ( ABC- Activity Based Standard Costing )

Tanza-Cola Ltd . Is a company involved in the production and sale of a favourite drink known as Tanza-
Cola’ The standard ingredients of 1 litre of Tanza-Cola are:
0.65 liter of ingredient P @ Tshs. 4,000 per liter
0.30 liter of ingredient Q @ Tshs. 6,000 per liter
0.20 liter of ingredient R @ Tshs. 2,500 per liter
Production of 4,000 liter of Tanza-Cola was budgeted for January , 2014. The production of Tanza-Cola
is entirely automated and production costs attributed to Tanza-Cola production comprise only direct
materials and overheads.
The Tanza- Cola production operation works on a JIT basis and no ingredients or Tanza-Cola inventories
are hels.
Overheads were budgeted for January, 2014 for the Tanza-Cola production operation as follows:
Activity Total Amount ( Tshs)
Receipt of deliveries from suppliers 4,000,000
( standard delivery quantity is 460 liters )
Dispatch of goods to customers
( standard dispatch quantity is 100 litre ) 8,000,000
Total 12,000,000
In January 2014, 4,200 litres of Tanza-Cola were produced and cost details were as follows:
Material used:
2,840 litres of P , 1,210 litres of Q and 860 litres of R a total cost of Tshs. 20,380,000
Actual overhead costs:
12 supplier deliveries at total cost of Tshs. 4,800,000 were made and 38 customer dispatcher at a total
cost of Tshs. 7,800,000 were processed.
Tanza – Cola Ltd’s Budget Commited met to discuss the preparation of the financial control report for
January 2014 and the following discussion occurred.
Chief Accountant:
“The overheads do not vary directly with output and are therefore by definition fixed. They should be
analyzed and reported accordingly”
Management Accountant:
“The overheads do not vary with output , but they are certainly not fixed. They should be analyzed and
reported on activity basis
Require:
Having regard to this discussion
(a )Prepare a variable analysis for Tanza-Cola production costs in January separating the material
costs variance into price, mix and yield components. Also separate the overhead costs variances into
expenditure, capacity and efficiency components using consumption of ingredient P as overhead
absorption base.
(b)Prepare an activity-based costing variance analyzed and reconciliation statement for production
overhead costs for Tanza-Cola in January 2014 ( 9 marks )
( c )Explain how, in the design of an Activity-Based Costing ( ABC ) system, you would identify and
select the most appropriate activities and cost drivers.

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

Question.10
How ABC IS USED IN Profitability Management, Performance Measurements, Sustainability, Human
Capital Management and Financial Planning?

Question.11 ( NBAA, Adapted )

Doto Limited manufactures three products A , B , and C . Data for the period just ended is as follows:
Product A B C
Output in units 20,000 25,000 2,000
Tshs / Unit Tshs /Unit Tshs / Unit
Direct material Cost 5,000 10,000 10,000
Total production Overhead Tshs 190m

Information for overhead absorption l;abou hour’s basis.

A B C
Labour hours / Unit 1 2 3
Labour is paid at the rate of Tshs 5,000 per hour.
Information for activity based costing
Tshs ‘000’
Machining 55,000
Quality control & set up cost 90,000
Receiving 15,000
Packing 190,000
Cost Driver Data
Machine hour /unit A B C
No. of production runs 2 2 2
No. of component receipts 10 13 2
No. of component orders 20 20 20
Required:
Calculate the total cost per unit for each production using
(a ) Traditional absorption costing production overheads are absorbed on the basis of labour
hours ( 8 marks )
( b) Activity based costing ( 12 marks )

CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI pg. 17
CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

Question.12 ( NBAA , Adapted )

Mtoni Kijichi Co. operates an activity based costing system and has forecast the following for the next
year.
Cost Pool Cost ( Tshs.) Cost driver Number of drivers
Production set ups 105,000,000 Set up 300
Production testing 300,000,000 Tests 1,500
Component supply and 25,000,000 Component orders 500
storage
Customers’ orders and 112,500,000 Customer’s orders 1,000
delivery

Generally fixed overheads such as lightning and heating. Which can-not be linked to any specific activity
are expected to be Tshs. 900,000,000 and these overheads are absorbed on the basis of direct labour hours
Mtoni Kijichi Co. specializes in production WEYE and heating and expects for WEYE next year to be
100 orders of 60 units per order and 60 order of 50 units per orders. The company holds no inventories of
product WEYE and will need to produce the order requirements in the production runs of 900 units. One
order for components is placed prior to each production run. Four tests are made during each production
run to ensure that quality standards are maintained.
The following additional costs and profit information relates to product WEYE.
Component Tshs. 1,000 per unit
Direct labour 10 minutes per unit at Tshs. 7,800 per hour
Profit mark up 40% of total unit costs.
Required :
( a) Calculate the activity based recovery rates for each cost pool (4marks)
(b ) Calculate the total unit cost and selling price of productive WEYE ( 8marks)
(C ) Discuss the reasons why activity based costing may be preferred to traditional absorption
costing in the modern manufactured environment. (8marks)

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

QUESTION.13 NBAA Nov 2015

Mwanga manufacturing company is a famous company for manufacturing and distribution of soap
products in all East Africa countries . The company manufactures two soap products namely “Red soap”
and Dark soap”
According to production manager , the company applies overhead on the basis of Direct labour hours
throughout the factory and the company anticipates that overhead and direct time for the upcoming
accounting period are TZS 3,200 and 50.ooo hours respectively.
Information about the company’s product as follows:
Read soap Dark soap
Estimated production volume 300 units 400 units
Direct material cost TZS 56 /unit TZS / unit
Direct labour per unit 6 hours @ TZS 30 per hour
The company overhead costs of TZS 3,200,000 can be identified with major activities order processing (
TZS 500,000), machine processing ( TZS 2,400,000) and product inspection ( TZS 300,000) These
activities are driven by the number of orders processed. Machine hours worked and inspection hours
respectively .
Data relevant to these activities are as follows:
Order processed Machine hours worked Inspection hours
Red soap 640 32,000 8,000
Dark soap 360 48,000 12,000
Total 1,000 80,000 20,000

Required:
(a ) Calculate the overhead absorption rates that will be used order processing , machine
processing and product inspection in an activity based costing system ( 3marks )
(b) Assume use of Activity based costing, compute the unit manufacturing cost of Red soap if
the expected manufactured volume is attained ( 6 marks )
(c )Compute
i. How much overhead cost would be applied to a unit of Red soap and Dark soap if
the company would have use traditional costing and applied overhead solely on the
basis of direct labour hour (6marks )
ii. using the answer in (i) above , show which of the two products would be
undercoated or overhead by this procedure (8 marks )
(d)State the major limitations of Activity bases costing ( 5 marks )

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CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI

QUESTION.14 NBAA Nov 2016 A.4

The following budgeted information related to Bongo ltd for the forthcoming period
XYZ YZT ABW
Sales and production(units) 50,000 40,000 30,000
Selling price per unit(TSH) 450 950 730
Prime cost per unit(TSH) 320 840 650
Machine department(machine hours per unit) 2 5 4
Assembly department(labour per unit) 7 3 2
Overhead allocated and apportioned to production departments (including service cost centre) were to be
recovered in product cost as follows
Machine department TSH 12 per machine hour
Assembly department TSH 8.25 per direct labour hour
You ascertain the above overheads could be analysed into cost pools as follows:
Tsh cost driver Quality for the period
Machine service 3,570,000 machine hours 420,000
Assembly 3,180,000 Labour hours 530,000
Set up costs 262,500 Set ups 500
Order processing 1,560,000 customer orders 32,000
Purchasing 840,000 suppliers orders 11,200
You have also been provided with the following estimates for the period
XYZ YZT ABW
Number of set ups 100 200 200
Customer orders 8,000 8,000 16,000
Suppliers’ orders 3,000 4,000 4,200
REQUIRED
Prepare and present profit statement using
(a) Convention absorption costing
(b) Activity based costing
(c) Comment on why activity based costing is considered to present a fair valuation of the
product cost per unit.

CPA&CISA MARK SAM MTATURU 0768 777 333 Verified by DKT MWAMBULI pg. 20