Activity Based

6 Costing
CHAPTER

Meaning of Activity • According to CIMA London, “ABC Costing is the cost attribution to
Based Costing (ABC) cost units on the basis of benefits received from indirect activities, e.g.
ordering, setting up, assuring quality”.
• ABC assigns cost to activities based on their use of resources.
• It then assigns cost to cost objects, such as products or customers,
based on their use of activities.
Meaning of Activity • It here refers to an event that incurs cost.
• It comprises of units of work or tasks. Example, purchase of material is
an activity consisting a series of tasks like purchase requisition, follow-
up, etc.
Meaning of Cost • Anything for which cost is ascertained is known as cost object. It may
Object be a job, a product or a customer, etc. In the case of product, a cost
object may be a car, a TV set, a computer etc.
Meaning of Cost • It is a factor that causes a change in the cost of an activity.
Driver • It shows why resources are consumed by an activity.
• Cost drivers are of two types:
 Resource cost driver i.e. the measure of the quantity of resources
consumed by an activity
 Activity cost driver i.e. the measure of the frequency and intensity
of demand placed on the activities by cost object.
Meaning of Cost Pool • It is grouping of individual cost items. A cost pool is created for each
activity. Cost pool, also known as cost bucket, is like a cost center for
which costs are accumulated.
Factors Prompting • Growing overhead costs
the Development of • Increasing market competition requiring more accurate product cost
ABC • Increasing product diversity to secure economies of scope
• Decreasing cost of information processing
Usefulness or • High amount of overhead
Suitability of ABC • Wide range of products
• Presence of non-volume related activities
• Stiff competition
Comparison of Traditional Costing System Activity Based Costing System
Traditional and ABC • Uses from one to three • Uses activity based multiple
system volume based cost drivers cost drivers (including both
volume and non-volume
based)
• Assigns overhead costs first • Assigns overhead costs first to
to departments and then to activities and then to products
products or services or services
• Focuses on management • Focuses on processes and
responsibility for costs activities for cross functional
within departments problem solving.
Unit Level Activities • Unit level activities are the activities whose costs are strongly correlated
to the number of units produced.
• E.g. use of indirect material tends to increase in proportion to the
number of units produce.
Batch Level Activities • Batch level activities are the activities whose costs are driven by the
number of batches of units produced but is common or fixed for all
units within the batch.
• E.g. machine set-up cost where machines need resetting between each
different batch of production.
Production Level • In this case the cost of some of the activities are driven by the creation
Activities of a new product line and its maintenance.
• E.g. designing the product, technical drawings of products etc.
Facility Level • These are the activities which cannot be directly attributed to individual
Activities products.
• These are necessary to sustain the manufacturing process and are
common and joint to all products manufactured
• E.g. maintenance of buildings, plant security etc.
Steps Involved in • Step 1: Identify the various Activities within the organization
Activity Based Costing • Step 2: Relate the Overheads to the Activities using Resource Cost
Drivers
• Step 3: Apportion the costs of Support Activities over the Primary
Activities on suitable basis
• Step 4: Determine the Activity Cost Drivers for each Activity/Cost
Pool
• Step 5: Calculate Activity Cost Driver Rate
Total Cost of Activity Cost Pool
=
Activity Cost Driver

Activity Based Costing 183

Benefits of Activity • ABC provides more accurate and informative product costs, which
Based Costing lead to more accurate product profitability measurements and to
better-informed strategic decisions.
• ABC provides more accurate measurements of activity-driving
costs, which helps managers improve product and process value.
• ABC provides managers easier access to relevant costs for making
business decisions, enabling them to take a more competitive position.
Limitations of Activity • Allocations – Even if activity data are available, some costs probably
Based Costing require allocations to departments and products based on arbitrary
volume measures.
• Omission of costs – ABC omits from the analysis some costs
identified with specific products. Activities that cause such costs
include marketing, advertising, research and development, product
engineering, and warranty claims.
• Expense and time – An ABC system is very expensive to develop and
implement and is very time consuming.
Requirement in • Staff Training – It should be done to create an awareness of the
Implementation of purpose of ABC.
Activity Based Costing • Process Specification – Informal, but structure, interviews with
key members of personnel will identify the different stages of the
production process, the commitment of resources to each, processing
times and bottlenecks.
• Activity Definition – Early activity should be clearly defined the
problem must be kept manageable at this state, despite the possibility
of information overload from new data, much of which is in need to
codification.
• Activity Driver Selection - Cost driver for each activity shall be
selected.
• Assigning Cost – A single representative activity driver can be used to
assign costs from the activity pools to the cost objects.
Practical Applications • As a decision making tool
of Activity Based • As activity based management
Costing • Facilitate activity based budgeting
Activity Based • It refers to use of ABC as a costing tool to manage activity level costs.
Management • It involves various analysis which are as follows:
 Cost driver analysis
 Activity analysis to identify value added activities and non-value
added activities.
 Performance analysis
• It can be used in following ways:
 Cost reduction
 Business process re-engineering
 Benchmarking
 Performance measurement

184 Cost and Management Accounting PW

Activity Based • ABB analyse the resource input or cost for each activity.
Budgeting (ABB) • It provides a framework for estimating the amount of resources
required in accordance with the budgeted level of activity.
• Actual results can be compared with budgeted results to highlight
both in financial and non-financial terms those activities with major
discrepancies from budget for potential reduction in supply of
resources.
• The three elements of activity based budgeting are as follows:
 Type of work to be done
 uantity of work to be done
 Cost of work to be done
Benefits of Activity • ABB can enhance accuracy of financial forecasts and increasing
Based Budgeting management understanding
(ABB) • When automated, ABB can rapidly and accurately produce financial
plans and models based on varying levels of volume assumptions
• ABB eliminates much of the needless rework created by traditional
budgeting techniques

PRACTICE QUESTIONS
1. A company manufacturing two products furnishes the following data for a year:
[Similar May 2018, Similar Nov 2022]

Product Annual Total Machine Total number of Total number of

Output hours purchase orders set-ups
(Units)
S 5,000 20,000 160 20
K 60,000 1,20,000 384 44

The annual overheads are as under: `

Volume related activity costs 5,50,000
Set up related costs 8,20.000
Purchase related costs 6,18,000
ou are required to calculate the cost per unit of each product S and K based on:
(i) Traditional method of charging overheads,
(ii) Activity based costing method.
Ans. (i) `56.80; `28.40; (ii) `103.32; `24.53.

Activity Based Costing 185

 2. SK Ltd. is a multiproduct company, manufacturing three products S, K and M. the budgeted costs
and production for the year ending March 31st, are as follows: [SM]
S K M
Production quantity (units) 4,000 3,000 1,600
Resources per unit:
Direct Material (Kg) 4 6 3
Direct labour (Minutes) 30 45 60
The budgeted direct labour rate was `10 per hour and the budgeted materials cost was `2 per
Kg. Production overheads were budgeted at `99,450 and were absorbed to products using the
direct labour hour rate. SK Ltd. followed an Absorption Costing System.
SK Ltd. is in consideration to adopt an Activity Based Costing System. The following additional
information is made available for this purpose:
(a) Budgeted overheads were analyzed into the following:
Material handling `29,100
Storage costs `31,200
Electricity `39,150
(b) The cost drivers identified were as follows:
Material handling Weight of material handled
Storage costs Number of batches of material
Electricity Number of machine operators
(c) Data on Cost Drivers was as follows:
S K M
For complete production:
Batches of material 10 5 15
Per unit of production:
Number of machine operators 6 3 2
You are required to:
(a) Prepare a statement for management showing the unit costs and total costs of each product
using the absorption costing method.
(b) Prepare a statement for management showing the products costs of each product using the
ABC approach
(c) What are the reasons for the different product costs under the two approaches
Ans. (a) `21.50; `32.25; `33; (b) `25.09; `28.97; `30.16.

3. SK Ltd. has collected the following data for its two activities. It calculates activity cost rates based
on cost driver capacity: [SM]

Activity Cost Driver Capacity Cost

Power Kilowatt hours 50,000 kilowatt hours `2,00,000
Quality inspections No. of inspections 10,000 inspections `3,00,000
The company makes three products S, K and M. For the year ended March 31, the following
consumption of cost driver was reported:
186 Cost and Management Accounting PW
 Product Kilowatt Hours Quality Inspections
S 10,000 3,500
K 20,000 2,500
M 15,000 3,000
Required:
(i) Compute the costs allocated to each product from each activity
(ii) Calculate the cost of unused capacity for each activity
(iii) Discuss the factors the management considers in choosing a capacity level to compute the
budgeted fixed overhead cost rate.
Ans. (i) Total Power = `1,80,000; Total Inspection = `2,70,000; (ii) `20,000; `30,000.

4. ‘Humara – Apna’ bank offers three products, viz. deposits, Loans and Credit Cards. The bank has
selected 4 activities for a detailed budgeting exercise, following activity based costing method.
[SM]
The bank wants to know the product wise total cost per unit for the selected activities, so that price
may be fixed accordingly. The following information is made available to formulate the budget:
Activity Present Cost Estimation for the budget period
(`)
ATM Services:
(a) Machine Maintenance 4,00,000 All fixed, no change
(b) Rents 2,00,000 Fully fixed, no change
(c) Currency replenishment cost 1,00,000 Expected to double during budget
7,00,000 (This activity is driven by no. of ATM
transactions)
Computer Processing 5,00,000 Half this amount is fixed and no change is
expected.
The variable portion is expected to
increase to three times the current level.
(This activity is driven by the number of
computer transactions)
Issuing Statements 18,00,000 Presently, 3 lakh statements are made. In
the budget period, 5 lakh statements are
expected.
For every, increase of one lakh statement,
one lakh rupees is the budgeted increase.
(This activity is driven by the number of
statements)
Computer Inquiries 2,00,000 Estimated to increase by 80 during the
budgeted period.
(This activity is driven by telephone
minutes)
Activity Based Costing 187
 The activity drivers and their budgeted quantities are given below:
Activity Drivers Deposits Loans Credit Cards
No. of ATM transactions 1,50,000 - 50,000
No. of Computer Processing Transactions 15,00,000 2,00,000 3,00,000
No. of Statements to be issued 3,50,000 50,000 1,00,000
Telephone Minutes 3,60,000 1,80,000 1,80,000
The bank budgets a volume of 58,600 deposit accounts, 13,000 loan accounts and 14,000 credit card
accounts.
Required:
(i) Calculate the budgeted rate for each activity
(ii) Prepare the budgeted cost statement activity wise.
(iii) Compute the budgeted product cost per account for each product using (i) and (ii) above.
Ans. (i) `4; `0.50; `4; `0.50; (ii) `58,600; `13,000; `14,000; (iii) `50; `30; `60.

5. SK is a global brand created by SK Ltd. The company manufactures three range of beauty soaps
i.e. SK-Gold, SK-Pearl, and SK-Diamond. The budgeted costs and production for the month of
March, 2021 are as follows: [SM]
SK-Gold SK-Pearl SK-Diamond
Production of
4,000 3,000 2,000
soaps (Units)
Resources per Qty Rate Qty Rate Qty Rate
Unit:
- Essential Oils 60 ml `200/100 ml 55 ml `300/100 ml 65 ml `300/100 ml
- Cocoa Butter 20 g `200/100 g 20 g `200/100 g 20 g `200/100 g
- Filtered Water 30 ml `15/100 ml 30 ml `15/100 ml 30 ml `15/100 ml
- Chemicals 10 g `30/100 g 12 g `50/100 g 15 g `60/100 g
- Direct Labour 30 `10/hour 40 `10/hour 60 `10/hour
Min. Min. Min.

SK Ltd. followed an Absorption Costing System and absorbed its production overheads, to its products
using direct labour hour rate, which were budgeted at `1,98,000.
Now, SK Ltd. is considering adopting an Activity Based Costing system. For this, additional information
regarding budgeted overheads and their cost drivers is provided below:
Particulars (`) Cost drivers
Forklifting cost 58,000 Weight of material lifted
Supervising cost 60,000 Direct labour hours
Utilities 80,000 Number of Machine operations

188 Cost and Management Accounting PW

The number of machine operations per unit of production are 5, 5, and 6 for SK-Gold, SK-Pearl, and
SK-Diamond respectively.
(Consider (i) Mass of 1 litre of Essential Oils and Filtered Water equivalent to 0.8 kg and 1 kg
respectively (ii) Mass of output produced is equivalent to the mass of input materials taken together.)
You are requested to:
(i) Prepare a statement showing the unit costs and total costs of each product using the
absorption costing method.
(ii) Prepare a statement showing the product costs of each product using the ABC approach.
(iii) State what are the reasons for the different product costs under the two approaches
Ans. (i) `189; `244.17; `291.50; (ii) `192.48; `243.70; `285.72.

6. The profit margin of BAB Hairclips Company were over 20 of sales producing BROWN and
BLACK hairclips. [RTP Nov 2022]
During the last year, GREEN hairclips had been introduced at 10 premium in selling price after the
introduction of ELLO hairclips earlier five years back at 10/3 premium. However, the manager
of the company is disheartened with the sales figure for the current financial year as follows:

Traditional Income Statement (in `)

Brown Black Yellow Green Total

Sales 1,50,00,000 1,20,00,00 27,90,000 3,30,000 3,01,20,000
Material costs 50,00,000 40,00,000 9,36,000 1,10,000 1,0046,000
Direct labour 20,00,000 16,00,000 3,60,000 40,000 40,00,000
Overheads (3 times of 60,00,000 48,00,000 10,80,000 1,20,000 1,20,00,000
direct labour)
Total operating income 20,00,000 16,00,000 4,14,000 60,000 40,74,000
Return on sales (in ) 13.3 13.3 14.8 18.2 13.5
It is a known fact that customer are ready to pay premium amount for ELLOW and GREEN
hairclips for their attractiveness; and the percentage returns are also high in new products.
At present, all of the Plant’s indirect expenses are allocated to the products at 3 times of the direct
labour expenses. However, the manager is interested in allocating indirect expenses on the basis
of activity cost to reveal real earner. He provides support expenses category-wise as follows:

Support Expenses (`)

Indirect labour 40,00,000
Labour Incentives 32,00,000
Computer Systems 20,00,000
Machinery depreciation 16,00,000
Machine maintenance 8,00,000
Energy for machinery 4,00,000
Total 1,20,00,000

Activity Based Costing 189

BACK YR DETA LABOUR INCE ALREADY KR DIYE NO TREATMENT
 He provides following additional information for accomplishment of his interest:
Incentive to be allocated 40 of labour expenses (both direct and indirect).
Indirect labour are involved mainly in three activities. About half of indirect labour is involved
in handling production runs. Another 40 is required just for the physical changeover from one
color hairclip to another because ELLO hairclips require substantial labour for preparing the
machine as compared to other colour hairclips. Remaining 10 of the time is spent for maintaining
records of the products in four parts.
Another amount spent on computer system of `20,00,000 is for maintenance of documents
relating to production runs and record keeping of the four products. In aggregate, approx. 80
of the amount expend is involved in the production run activity and approx. 20 is used to keep
records of the products in four parts.
Other overhead expenses i.e. machinery depreciation, machine maintenance and energy for
machinery are incurred to supply machine capacity to produce all the hairclips (practical capability
of 20,000 hours). MACHINE HR KE HISAB SE
Activity Cost Drivers:

Particulars Brown Black Yellow Green Total

Sales volume (units) 1,00,000 80,000 18,000 2,000 2,00,000
Selling price (`) 150 150 155 165
Material cost (`) 50 50 52 55
Machine hours per unit (Hrs) 0.10 0.10 0.10 0.10 20,000
Production runs 100 100 76 24 300
Setup time per run (Hrs) 4 1 6 4
You are required to:
(i) Calculate operating income and operating income as per percentage of sales using activity-
based costing system
(ii) State the reasons for different operating income under traditional income system and
activity based costing system.
Ans. (i) 21.61 ; 22,67 ; -44 ; -200.12 .

7. SK Limited has decided to analyse the profitability of its five new customers. It buys bottled water
at `90 per case and sells to retail customers at a list price of `108 per case. The data pertaining
to five customers are: [SM, Similar Nov 2019]

Customers
S K M P J
Cases sold 4,680 19,688 1,36,800 71,550 8,775
List selling price `108 `108 `108 `108 `108
Actual selling price `108 `106.20 `99 `104.40 `97.20
Number of purchase order 15 25 30 25 30
Number of Customer visits 2 3 6 2 3

190 Cost and Management Accounting PW

 Customers
S K M P J
Number of deliveries 10 30 60 40 20
Kilometers travelled per 20 6 5 10 30
delivery
Number of expedited deliveries 0 0 0 0 1

Its five activities and their cost drivers are:

Activity Cost Driver Rate

Order taking `750 per purchase order
Customer visits `600 per customer visit
Deliveries `5.75 per delivery km travelled
Product handling `3.75 per case sold
Expedited deliveries `2,250 per expedited delivery

Required:
(a) Compute the customer level operating income of each of five retail customers now being
examined (S, K, M, P and J). Comment on the results.
(b) What insights are gained by reporting both the list selling price and the actual selling price
for each customer.
Ans. (a) `53,090; `2,23,531; `6,90,375; `7,39,757; 274.

PRACTICE QUESTIONS
8. SK Ltd. manufactures three types of products namely P, and R. The data relating to a period are
as under: [SM, Similar May 2022]

Particulars S K M
Machine hours per unit 10 18 14
Direct Labour hours per unit 4 12 8
Direct Material per unit (`) 90 80 120
Production (units) 3,000 5,000 20,000

Currently the company uses traditional costing method and absorbs all production overheads
on the basis of machine hours. The machine hour rate of overhead is `6 per hour. Direct labour
hour rate is `20 per hour.

Activity Based Costing 191

 The company proposes to use activity based costing system and the activity analysis is as under:
Particulars S K M
Batch size (units) 150 500 1,000
Number of purchase orders per batch 3 10 8
Number of inspections per batch 5 4 3

The total production overheads are analysed as under:

Machine set up costs 20
Machine operations costs 30
Inspection costs 40
Material procurement related costs 10
Required:
(i) Calculate the cost per unit of each product using traditional method of absorbing all
production overheads on the basis of machine hours.
(ii) Calculate the cost per unit of each using activity based costing principles.
Ans. (i) `230; `428; `364; (ii) `427; `425; `335.20.

9. P R Ltd. is engaged in the production of three products P, and R. The company calculates Activity
Cost Rates on the basis of Cost Driver capacity which is provided as below: [July 2021]

Activity Cost Driver Cost Driver Capacity Cost (`)

Direct Labour Hours Labour Hours 30,000 Labour Hours 3,00,000
Production runs No. of Production runs 600 Production runs 1,80,000
Quality Inspections No. of Inspections 8000 Inspections 2,40,000

The consumption of activities during the period is as under:

Activity/Products P Q R
Direct Labour hours 10,000 8,000 6,000
Production runs 200 180 160
Quality Inspection 3,000 2,500 1,500

You are required to:

(i) Compute the cost allocated to each Product from each Activity.
(ii) Calculate the cost of unused capacity for each activity
(iii) A potential customer has approached the company for supply of 12,000 units of net product
‘S’ to be delivered in lots of 1,500 units per quarter. This will involve an initial design cost of
`30,000 and per quarter production will involve the following:

192 Cost and Management Accounting PW

 Direct Material `18,000
Direct Labour hours 1,500 hours
No. of Production runs 15
No. of uality Inspection 250
Prepare cost sheet segregating direct and indirect cost and compute the sales value per quarter
of product ‘S’ using ABC system considering a markup of 20 on cost.
Ans. (i) `2,50,000; `2,09,000; `1,53,000; (ii) `60,000; `18,000; `30,000; (iii) `58,500.

10. ABC Ltd. manufactures three products , and using the same plant and resources. It has given
the following information for the year ended on 31st March, 2020: [Jan 2021]

X Y Z
Production uantity (units) 1200 1440 1968
Cost per unit:
Direct Material (`) 90 84 176
Direct Labour (`) 18 20 30
Budgeted direct labour rate was `4 per hour and the production overheads, shown in table below,
were absorbed to products using direct labour hour rate. Company followed Absorption Costing
Method. However, the company is now considering adopting Activity Based Costing Method.

Budgeted Cost Driver Remarks

Overheads (`)

Material 50,000 No. of orders No. of orders was 25 for each

Procurement product

Set-up 40,000 No. of Production All the three products are produced
Runs in production runs of 48 units.

Quality Control 28,240 No. of Inspections Done for each production run.

Maintenance 1,28,000 Maintenance Total maintenance hours were

Hours 6,400 and was allocated in the
ratio of 1:1:2 between , and .

Required:
(i) Calculate the total cost per unit of each product using the Absorption Costing Method.
(ii) Calculate the total cost per unit of each product using the Activity Based Costing.
Ans. (i) `148.50; `149; `273.50; (ii) `163.37; `152.60; `261.80.

11. SK Ltd. Manufactures two types of machinery equipment S and K and applies/absorbs overheads
on the basis of direct-labour hours. The budgeted overheads and direct labour hours for the month
of December, are `12,42,500 and 20,000 hours respectively. The information about Company’s
products are as follows: [SM]

Activity Based Costing 193

 Equipment S Equipment K
Budgeted Production volume 2,500 units 3,125 units
Direct material cost `300 per unit `450 per unit
Direct labour cost
S: 3 hours `150 per hour `450
K: 4 hours `150 per hour `600
SK Ltd.’s overheads of `12,42,500 can be identified with three major activities:
Order processing (`2,10,000), machine processing (`8,75,000) and product inspection (`1,57,500).
These activities are driven by number of orders processed, machine hours worked and inspection
hours, respectively. The data relevant to these activities is as follows:
Order processed Machine hours Inspection hours
worked
S 350 23,000 4,000
K 250 27,000 11,000
Total 600 50,000 15,000
Required:
(a) Assuming use of direct-labour hours to absorb/apply overheads to production, compute the
unit manufacturing cost of the equipment S and K, if the budgeted manufacturing volume is
attained.
(b) Assuming use of activity-based costing, compute the unit manufacturing costs of the
equipment S and K, if the budgeted manufacturing volume is achieved.
(c) SK Ltd.’s selling prices are based heavily on cost. By using direct-labour hours as an
application based, calculate the amount of cost distortion (under-costed or over-costed) for
each equipment.
Ans. (a) `963.38; `1,298.50; (b) `976.80; `1,266.16; (c) -`40.42; +`32.34.

12. SK Pvt. Ltd. manufactures three products using three different machines. At present the overheads
are charged to products using labour hours. The following statement for the month of March
2021, using the absorption costing method is been prepared: [RTP Nov 2019]

Particulars Product S Product K Product P

(using Machine A) (using Machine B) (using Machine C)
Production units 45,000 52,500 30,000
Material cost per unit (`) 350 460 410
Wages per unit `80 per 240 400 560
hour
Overhead cost per unit (`) 240 400 560
Total cost per unit (`) 830 1,260 1,530
Selling price (`) 1,037.50 1,575 1,912.50

194 Cost and Management Accounting PW

 The following additional information is available relating to overhead cost drivers:
Cost driver Product S Product K Product P Total
No. of machine set-ups 40 160 400 600
No. of purchase orders 400 800 1,200 2,400
No. of customers 1,000 2,200 4,800 8,000
Actual production and budgeted production for the month is same. Workers are paid at standard
rate. Out of total overhead costs, 30 related to machine set-ups, 30 related to customer order
processing and customer complaint management.
Required:
(a) Compute overhead cost per unit using activity based costing method
(b) Determine the selling price of each product based on activity based costing with the same
profit mark-up on cost.
Ans. (a) `129.60; `268.40; `955.80; (b) `899.50; `1,410.57; `2,407.25.

13. SK Ltd. is a manufacturer of a range of goods. The cost structure of its different products is as
follows: [RTP May 2018]

Particulars Product S Product K Product M

Direct Materials 50 40 40 `/u
Direct Labour `10/hour 30 40 50 `/u
Production Overheads 30 40 50 `/u
Total Cost 110 120 140 `/u
Quantity Produced 10,000 20,000 30,000 Units
SK Ltd. was absorbing overheads on the basis of direct labour hours. A newly appointed
management accountant has suggested that the company should introduce ABC system and has
identified cost drivers and cost pools as follows:
Activity Cost Pool Cost Driver Associated Cost (`)
Stores Received Purchase Requisitions 2,96,000
Inspection Number of Production Runs 8,94,000
Dispatch Orders Executed 2,10,000
Machine Setup Number of Setups 12,00,000
The following information is also supplied:
Details Product S Product K Product M
No. of Setups 360 390 450
No. of Orders Executed 180 270 300
No. of Production Runs 750 1,050 1,200
No. of Purchase Requisitions 300 450 500
Required to calculate activity based production cost of all the three products.
Ans. `150.49; `124.25; `123.67.

Activity Based Costing 195

14. SK Limited manufactures three products S, K and M which are similar in nature and are usually
produced in production runs of 100 units. Product S and M require both machine hours and
assembly hours, whereas product K requires only machine hours. The overheads incurred by the
company during the first quarter are as under: [MTP May 2019]
Machine Department expenses `18,48,000
Assembly Department expenses `6,72,000
Setup costs `90,000
Stores receiving cost `1,20,000
Order processing and dispatch `1,80,000
Inspect and Quality control cost `36,000
The data related to the three products during the period are as under:
S K M
Units produced and sold 15,000 12,000 18,000
Machine hours worked 30,000 hrs. 48,000 hrs. 54,000 hrs.
Assembly hours worked (direct labour hours) 15,000 hrs. - 27,000 hrs.
Customers’ orders executed (in numbers) 1,250 1,000 1,500
Number of requisitions raised on the stores 40 30 50
Required:
Prepare a statement showing details of overhead costs allocated to each product type using
activity based costing.
Ans. `8,02,000; `7,83,600; `13,60,400.

15. Bank of SK operated for years under the assumption that profitability can be increase by increasing
Rupee volume. But that has not been the case. Cost analysis has revealed the following:
[MTP May 2018]

Activity Activity Cost (`) Activity Driver Activity Capacity

Providing ATM Service 1,00,000 No. of Transactions 2,00,000
Computer Processing 10,00,000 No. of Transactions 25,00,000
Issuing Statements 8,00,000 No. of Statements 5,00,000
Customer Inquiries 3,60,000 Telephone Minutes 6,00,000

The following annual information on three products was also made available:
Activity Driver Checking Accounts Personal Loans Gold Visa
Units of Product 30,000 5,000 10,000
ATM Transactions 1,80,000 0 20,000
Computer Transactions 20,00,000 2,00,000 3,00,000
Number of Statements 3,00,000 50,000 1,50,000
Telephone Minutes 3,50,000 90,000 1,60,000

196 Cost and Management Accounting PW

 Required:
(a) Calculate rates for each activity
(b) Using the rates computed in required (a), calculate the cost of each product.
Ans. (a) `0.50; `0.40; `1.60; `0.60; (b) `52.67; `42.80; `46.60.

16. MNO Ltd. manufactures two types of equipment A and B and absorbs overheads on the basis of
direct labour hours. The budgeted overheads and direct labour hours for the month of March 2019
are `15,00,000 and 25,000 hours respectively. The information about the company’s products is
as follows: [May 2019]

Equipment
A B
Budgeted Production Volume 3,200 units 3,850 units
Direct Material Cost `350 per unit `400 per unit
Direct Labour Cost
A: 3 hours `120 per hour `360
B: 4 hours `120 per hour `480
Overheads of `15,00,000 can be identified with the following three major activities:
Order Processing `3,00,000
Machine Processing `10,00,000
Product Inspection `2,00,000
These activities are driven by the number of orders processed, machine hours worked and
inspection hours respectively. The data relevant to these activities is as follows:

Orders Processed Machine hours worked Inspection hours

A 400 22,500 5,000
B 200 27,500 15,000
Total 600 50,000 20,000

Required:
(i) Prepare a statement showing the manufacturing cost per unit of each product using the
absorption costing method assuming the budgeted manufacturing volume is attained.
(ii) Determine cost driver rates and prepare a statement showing the manufacturing cost per
unit of each product using activity based costing, assuming the budgeted manufacturing
volume is attained.
(iii) MNO Ltd.’s selling prices are based heavily on cost. By using direct labour hours as an
application base, calculate the amount of cost distortion (under costed or over costed) for
each equipment.
Ans. (i) `890; `1,120; (ii) `928.75; `1,087.79; (iii) -`38.75; + `32.21.

Activity Based Costing 197

17. The following budgeted information relates to N Ltd. for the year 2021: [RTP May 2021]

Products
X Y Z
Production and Sales (Units) 1,00,000 80,000 60,000
(`) (`) (`)
Selling price per unit 90 180 140
Direct cost per unit 50 90 95
Hours Hours Hours
Machine department 3 4 5
(machine hours per unit)
Assembly department 6 4 3
(direct labour hours per unit)

The estimated overhead expenses for the year 2021 will be as below:
Machine Department `73,60,000
Assembly Department `55,00,000
Overhead expenses are apportioned to the products on the following basis:
Machine Department On the basis of machine hours
Assembly Department On the basis of labour hours
After a detailed study of the activities the following cost pools and their respective cost drivers
are found:
Cost Pool Amount (`) Cost Driver Quantity
Machining services 64,40,000 Machine hours 9,20,000 hours
Assembly services 44,00,000 Direct labour hours 11,00,000 hours
Set-up costs 9,00,000 Machine set-ups 9,000 set-ups
Order processing 7,20,000 Customer orders 7,200 orders
Purchasing 4,00,000 Purchase orders 800 orders

As per an estimate the activities will be used by the three products:

Products
X Y Z
Machine set-ups 4,500 3,000 1,500
Customer orders 2,200 2,400 2,600
Purchase orders 300 350 150
ou are required to prepare a product-wise profit statement using:
(a) Absorption costing method;
(b) Activity-based method.
Ans. (a) (`14,00,000); `30,40,000; (`6,00,000); (b) (`13,20,000); `29,65,000; (`6,05,000).

198 Cost and Management Accounting PW

18. RST Limited specializes in the distribution of pharmaceutical products. It buys from the
pharmaceutical companies and resells to each of the three different markets. [SM]
(a) General Supermarket Chains
(b) Drugstore Chains
(c) Chemist Shops
The following data for the month of April, 2004 in respect of RST Limited has been reported:

General Super Drugstore Chemist Shops

Market Chains Chains (`) (`)
(`)

Average revenue per delivery 84,975 28,875 5,445

Average cost of goods sold per 82,500 27,500 4,950

delivery

Number of deliveries 330 825 2,750

In the past, RST Limited has used gross margin percentage to evaluate the relative profitability
of its distribution channels. The company plans to use activity-based costing for analyzing the
profitability of its distribution channels.
The activity analysis of RST Limited is as under:
Activity Area Cost Driver
Customer purchase order processing Purchase orders by customers
Line-item ordering Line-items per purchase order
Store delivery Store deliveries
Cartons dispatched to stores Cartons dispatched to a store per delivery
Shelf-stocking at customer store Hours of shelf-stocking
The April, 2004 operating costs (other than cost of goods sold) of RST Limited are `8,27,970.
These operating costs are assigned to five activity areas. The cost in each area and the quantity
of the cost allocation basis used in that area for April, 2004 are as follows:
Activity Area Total costs in Total Unit of costs allocation
April 2004 (`) base used in April 2004
Customer purchase order processing 2,20,000 5,500 orders

Line-item ordering 1,75,560 58,520 line items

Store delivery 1,95,250 3,905 store deliveries

Cartons dispatched to store 2,09,000 2,09,000 cartons

Shelf-stocking at customer store 28,160 1,760 hours

Activity Based Costing 199

 Other data for April, 2004 include the following:
General Super Drugstore Chemist Shops
Market Chains Chains
Total number of orders 385 990 4,125
Average number of line items per order 14 12 10
Total number of store deliveries 330 825 2,750
Average number of cartons shipped per 300 80 16
store delivery
Average number of hours of shelf-stocking 3 0.6 0.1
per store delivery
Required:
(a) Compute for April, 2004 gross-margin percentage for each of its three distribution channels
and compute RST Limited’s operating income.
(b) Compute the April, 2004 rate per unit of the cost-allocation base for each of the five activity
areas.
(c) Compute the operating income of each distribution market in April, 2004 using the activity-
based costing information. Comment on the results. What new insights are available with
the activity-based cost information
Ans. (a) 2.91 ; 4.76 ; 9.09 ; (b) `40; `3; `50; `1; `16; (c) `6,53,840; `9,43,965; `8,86,600.

19. A drug store is presently selling three types of drugs namely ‘Drug A’, ‘Drug B’ and ‘Drug C’. due
to some constraints, it has decided to go for only one product line of drugs. It has provided the
following data for the year 2020-21 for each product line: [SM, Dec 2021]

Drug Types
A B C
Revenue (in `) 74,50,000 1,11,75,000 1,86,25,000
Cost of goods sold (in `) 41,44,500 68,16,750 1,20,63,750
Number of purchase orders placed (in nos) 560 810 630
Number of deliveries received 950 1,000 850
Hours of shelf-stocking time 900 1,250 2,350
Units sold (in nos) 1,75,200 1,50,300 1,44,500
Following additional information is also provided:
Activity Description of Activity
Total Cost (`) Cost-allocation base
Drug License fee Drug License fee 5,00,000 To be distributed in ratio 2:3:5
between A, B and C
Ordering Placing of orders for 8,30,000 2,000 purchase orders
purchases

200 Cost and Management Accounting PW

 Activity Description of Activity Total Cost (`) Cost-allocation base
Delivery Physical delivery and 18,20,000 2,800 deliveries
receipt of goods
Shelf stocking Stocking of goods 32,40,000 4,500 hours of shelf-stocking
time
Customer Assistance provided to 28,20,000 4,70,000 units sold
Support customers
You are required to:
(i) Calculate the operating income and operating income as a percentage ( ) of revenue of each
product line if:
(a) All the support costs (other than cost of goods sold) are allocated in the ratio of cost
of goods sold
(b) All the support costs (Other than cost of goods sold) are allocated using activity-based
costing system.
(ii) Give your opinion about choosing the product line on the basis of operating income as a
percentage ( ) of revenue of each product line under both the situation as above.
Ans. (i) (a) 22.12 ; 14.60 ; 9.32 ; (b) 8.81 ; 12.71 ; 15.78 .

SOLUTION OF PRACTICE QUESTIONS

8.
(i) Statement showing cost per unit – Traditional Method
Particulars P Q R
Direct material 90 80 120
Direct labour (4, 12, 8 hours) × `20] 80 240 160
Production overheads (10, 18, 14 hours) × `6] 60 108 84
Cost per unit 230 428 364
(ii) Total machine hours = (3,000 × 10) + (5,000 × 18) + (20,000 × 14) = 4,00,000
Total production overheads = 4,00,000 × `6 = `24,00,000
Particulars P Q R Total
A. Production (units) 3,000 5,000 20,000
B. Batch size (units) 150 500 1,000
C. Number of batches (A ÷ B) 20 10 20 50
D. Number of purchase order per batch 3 10 8
E. Total purchase order (C × D) 60 100 160 320
F. Number of inspections per batch 5 4 3
G. Total inspections (C × F) 100 40 60 200

Activity Based Costing 201

 Statement of cost driver rate
Activity Overhead (`) Cost driver quantity Cost driver rate (`)
Setup 24,00,000 × 20 50 batches 9,600 per batch
= 4,80,000
Inspection 24,00,000 × 40 200 inspections 4,800 per inspection
= 9,60,000
Purchases 24,00,000 × 10 320 purchases 750 per purchase
= 2,40,000
Machine 24,00,000 × 30 4,00,000 machine 1,80 per machine hour
operations = 7,20,000 hours

Statement showing cost per unit – Activity Based Costing Method

Particulars P Q R
Production units 3,000 5,000 20,000
(`) (`) (`)
Direct material (90, 80, 120) 2,70,000 4,00,000 24,00,000
Direct labour (80, 240, 160) 2,40,000 12,00,000 32,00,000
Machine related costs (30,000, 50,000, 20,000) × 54,000 1,62,000 5,04,000
`1.80
Setup costs (20, 10, 20) × `9,600] 1,92,000 96,000 1,92,000
Inspection cost (100, 40, 60) × `4,800] 4,80,000 1,92,000 2,88,000
Purchase related costs (60, 100, 160) × `750 45,000 75,000 1,20,000
Total Costs 12,81,000 21,25,000 67,04,000
Cost per unit (Total cost ÷ Units) 427 425 335.20

9.
(i) Statement of Cost Driver Rate
Activity Amount Cost driver (B) Cost Driver Rate (A÷B)
(A)
Direct Labour 3,00,000 30,000 Labour Hours `10 per labour hour
Hours
Production runs 1,80,000 600 Production runs `300 per production run
Quality Inspections 2,40,000 8000 Inspections `30 per inspection
Statement of Cost
Particulars P Q R Total
Direct labour 10 × 10,000 10 × 8,000 10 × 6,000
hour = 1,00,000 = 80,000 = 60,000 2,40,000
Production run 300 × 200 300 × 180 300 × 160
= 60,000 = 54,000 = 48,000 1,62,000

202 Cost and Management Accounting PW

 Particulars P Q R Total
Quality 30 × 3,000 30 × 2,500 30 × 1,500
inspection = 90,000 = 75,000 = 45,000 2,10,000
Total Cost 2,50,000 2,09,000 1,53,000 6,12,000

(ii) Statement of Cost of Unused Capacity

Activity Total Cost Cost Charged to Products Unused Cost

Direct Labour Hours 3,00,000 2,40,000 60,000
Production runs 1,80,000 1,62,000 18,000
Quality Inspections 2,40,000 2,10,000 30,000

(iii) Statement of Cost

Particulars Amount (`)

Direct material 18,000
30,000 3,750
Direct expenses (design cost) × 1,500
12,000

Prime Cost 21,750

Add: Overheads
Direct labour hours (1,500 10) 15,000
Production run (15 300) 4,500
uality inspection (250 30) 7,500

COS 48,750
Add: Profit (48,750 20 ) 9,750
Sales 58,500

10.
Working Note:
(1) Total labour hours and recovery rate
Particulars Product X Product Y Product Z Total
Production units 1,200 1,440 1,968 1,27,500
Labour hours per unit 18 4 = 4.50 20÷4 = 5 30 4 = 7.50
Total labour hours 5,400 7,200 14,760 27,360
Total Overheads - - - 2,46,240
OHs recovery rate - - - `9

Activity Based Costing 203

 (2) Cost per activity and driver

Activity Total cost Cost allocation base Cost driver rate

(1) ` (2) (3) (4)=[(2)÷(3)]

Material 50,000 25 3 = 75 orders `666.67 per order

Procurement
Set-up 40,000 1200 1440 1968 `416.67 per run
= 96 run
48 48 48
Quality Control 28,240 1200 1440 1968 `294.17 per run
= 96 run
48 48 48

Maintenance 1,28,000 6,400 hours `20 per hour

(i) Statement of Cost per unit

Particulars X Y Z
Direct material 90 84 176
Direct labour 18 20 30
Overheads 9 4.50 = 40.50 9×5 = 45 9 7.50 = 67.50
148.50 149 273.50

(ii) Statement of Cost per unit

Particulars X Y Z
Direct material 90 84 176
Direct labour 18 20 30

Material 25 × 666.67 25 × 666.67 25 × 666.67

procurement = 13.89 = 11.57 = 8.47
1,200 1,440 1,968
Set-up cost 1,200 × 416.67 1,440 × 416.67 1,968 × 416.67
= 8.68 = 8.68
48 × 1,200 48 × 1,440 48 × 1,968
= 8.68
Quality control 1,200 × 294.17 1,440 × 294.17 1,968 × 294.17
cost = 6.13
48 × 1,200 = 6.13 48 × 1,440 48 × 1,968
= 6.13
Maintenance 1 1 2
20 × 6400 × 20 × 6400 × 20 × 6400 ×
4 4 4
= 26.67 = 22.22
1,200 1,440 1,968
= 32.52
Total Cost per unit 163.37 152.60 261.80

204 Cost and Management Accounting PW

11.
(a) Overhead application base: Direct Labour Hours
Equipment S Equipment K
(`) (`)
Direct material cost 300 450
Direct labour cost 450 600
Overheads (62.125 3) 186.38 248.50
(62.125 4)
936.38 1,298.50

Budgeted Overheads 12,42,500

Pre-determined overhead rate = = = `62.125
Budgeted direct labour hours 20,000
(b) Estimation of cost-driver rate
Activity Overhead Cost Cost-driver level Cost driver rate
(`) (`)
Order processing 2,10,000 600 order processed 350
Machine processing 8,75,000 50,000 machine hours 17.50
Inspection 1,57,500 15,000 inspection hours 10.50

Calculation of Overhead Costs

Activity Equipment S Equipment K
(`) (`)
Order Processing (350 350) (250 350) 1,22,500 87,500
Machine processing (23,000 17.50) (27000 17.50) 4,02,500 4,72,500
Inspection (4000 10.50) (11,000 10.50) 42,000 1,15,500
Total overhead cost 5,67,000 6,75,500
Total units 2,500 3,125
Overhead per unit 226.80 216.16

Calculation of cost per unit

Equipment S Equipment K
(`) (`)

Direct material cost 300 450

Direct labour cost 450 600

Overheads 226.80 216.16

976.80 1,266.16

Activity Based Costing 205

 (c) Statement of cost
Equipment S Equipment K
(`) (`)
Unit manufacturing cost-using direct labour hours as an 936.38 1,298.50
application base
Unit manufacturing cost-using activity based costing 976.80 1,266.16
Cost distortion (-) 40.42 + 32.34
Low volume product S is under-costed and high volume product K is over costed using direct
labour hours for overhead production.

12.
Working Note:
(1) Total labour hours and overhead cost:
Particulars Product S Product K Product P Total
Production units 45,000 52,500 30,000 1,27,500
Hour per unit 3 5 7
Total hours 1,35,000 2,62,500 2,10,000 6,07,500
Rate per hour - - - `80
Total Overheads - - - `4,86,00,000
(2) Cost per activity and driver

Activity Machine Set-up Customer Customer Total

order complaint
processing management
Total overheads (`) 1,45,80,000 1,45,80,000 1,94,40,000 4,86,00,000
No. of drivers 600 2,400 8,000
Cost per driver (`) 24,300 6,075 2,430
(a) Computation of Overhead cost per unit:
Particulars Product S Product K Product P
No. of machine set-up 40 160 400
Cost per driver (`) 24,300 24,300 24,300
Total machine set-up cost (`) (A) 9,72,000 38,88,000 97,20,000
No. of purchase orders 400 800 1,200
Cost per driver (`) 6,075 6,075 6,075
Total order processing cost (`) (B) 24,30,000 48,60,000 72,90,000
No. of customers 1,000 2,200 4,800
Cost per driver (`) 2,430 2,430 2,430

206 Cost and Management Accounting PW

 Particulars Product S Product K Product P
Total customer complaint 24,30,000 53,46,000 1,16,64,000
management cost (`) (C)
Total Overhead Cost (A + B + C) 58,32,000 1,40,94,000 2,86,74,000
Production units 45,000 52,500 30,000
Cost per unit (`) 129.60 268.40 955.80

(b) Determination of selling price per unit

Particulars Product S Product K Product P

(using (using (using
machine A) machine B) machine C)
Material cost per unit (`) 350.00 460.00 410.00
Wages per unit `80 per hour 240.00 400.00 560.00
Overhead cost per unit (`) 129.60 268.46 955.80
Total cost per unit (`) 719.60 1,128.46 1,925.80
Profit (25 profit mark-up) (`) 179.90 282.11 481.45
Selling price (`) 899.50 1,410.57 2,407.25

13. The total production overheads are `26,00,000:

Product S: 10,000 `30 = `3,00,000
Product K: 20,000 `30 = `8,00,000
Product M: 30,000 `30 = `15,00,000
On the basis of ABC analysis this amount will be apportioned as follows:
Particulars Basis Product S Product K Product M
Stores Receiving Purchase Requisition 71,040 1,06,560 1,18,400
6:9:10
Inspection Production Runs 2,23,500 3,12,900 3,57,600
5:7:8
Dispatch Orders Executed 50,400 75,600 84,000
6:9:10
Machine Set-ups Setups 3,60,000 3,90,000 4,50,000
12:13:15
Total Activity Cost 7,04,940 8,85,060 10,10,000
Quantity Produced 10,000 20,000 30,000
Units Cost (Overheads) 70.49 44.25 33.67
Add: Conversion cost 80 80 80
(Material + Labour)

Total 150.49 124.25 123.67

Activity Based Costing 207

14.
Calculation of Activity Rate
Cost pool Costs (`) Cost Driver Cost Driver Rate (`)
(A) (B) (A ÷ B)
Machine department 18,48,000 Machine hours 14.00
expenses – 1,32,000 hours
Assembly department 6,72,000 Assembly hours 16.00
expenses – 42,000 hours
Setup cost 90,000 No. of production runs 200.00
– 450
Stores receiving cost 1,20,000 No. of requisitions raised on 1,000.00
the stores – 120
Order processing and 1,80,000 No. of customers’ orders 48.00
dispatch executed – 3,750
Inspection and quality 36,000 No. of production runs 80.00
control cost – 450
Total (`) 29,46,000

Number of production runs is 450 (150 + 120 + 180)

Statement showing Overheads Allocation

Particulars S K M
Machine department expenses 4,20,000 6,72,000 7,56,000
(30,000 14) (48,000 14) (54,000 14)
Assembly department expenses 2,40,000 - 4,32,000
(15,000 16) (27,000 16)
Setup cost 30,000 24,000 36,000
(150 200) (120 200) (180 200)
Stores receiving cost 40,000 30,000 50,000
(40 1,000) (30 1,000) (50 1,000)
Order processing and dispatch 60,000 48,000 72,000
(1,250 48) (1,000 48) (1,500 48)
Inspection and quality control cost 12,000 9,600 14,400
(150 80) (120 80) (180 80)
Overheads (`) 8,02,000 7,83,600 13,60,400

208 Cost and Management Accounting PW

15.
(a) Statement showing Activity Rate
Activity Activity Activity Driver Activity Activity
Cost (`) Capacity Rate
Providing ATM Service 1,00,000 No. of Transactions 2,00,000 0.50
Computer Processing 10,00,000 No. of Transactions 25,00,000 0.40
Issuing Statements 8,00,000 No. of Statements 5,00,000 1.60
Customer Inquiries 3,60,000 Telephone Minutes 6,00,000 0.60

(b) Statement showing Cost of Product

Activity Checking Accounts Personal Loan Gold Visa
(`) (`) (`)
Providing ATM Service 1,80,000 0.50 - 20,000 0.50
= 90,000 = 10,000
Computer Processing 20,00,000 0.40 2,00,000 0.40 1,50,000 1.60
= 8,00,000 = 80,000 = 2,40,000
Issuing Statements 3,00,00 1.60 50,000 1.60 1,50,000 1.60
= 4,80,000 = 80,000 = 2,40,000
Customer Inquiries 3,50,000 0.60 90,000 0.60 1,60,000 0.60
= 2,10,000 = 54,000 = 96,000
Total Cost 15,80,000 2,14,000 4,66,000
Number of units 30,000 5,000 10,000
Cost per unit 52.67 42.80 46.60

16.
(i) Overhead application base: Direct Labour Hours
Equipment A (`) Equipment B (`)
Direct material cost 350 400
Direct labour cost 360 480
Overheads (60 3)(60 4) 180 240
890 1,120

Budgeted Overheads 15,00,000

Pre-determined overhead rate = = = `60
Budgeted direct labour hours 25,000

Activity Based Costing 209

 (ii) Estimation of cost-driver rate
Activity Overhead Cost (`) Cost-driver level Cost driver rate (`)

Order processing 3,00,000 600 order processed 500

Machine processing 10,00,000 50,000 machine hrs. 20

Inspection 2,00,000 15,000 inspection hrs. 10

Calculation of Overhead Costs

Activity Equipment A (`) Equipment B (`)

Order Processing (400 500) (200 500) 2,00,000 1,00,000
Machine processing (22,500 20) (27,500 20) 4,50,000 5,50,000
Inspection (5000 10) (10,000 10) 50,000 1,50,000
Total overhead cost 7,00,000 8,00,000
Total units 3,200 3,850
Overhead per unit 218.75 207.79

Calculation of cost per unit

Equipment A (`) Equipment B (`)
Direct material cost 300 400
Direct labour cost 360 480
Overheads 218.75 207.79
928.75 1,087.79

(iii) Statement of cost

Equipment A (`) Equipment B (`)

Unit manufacturing cost-using direct labour 890 1,120

hours as an application base

Unit manufacturing cost-using activity based 928.75 1,087.79

costing

Cost distortion (-) 38.75 + 32.21

210 Cost and Management Accounting PW

17.
(a) Statement of calculation of machine and labour hours
X Y Z Total
Production (units) (A) 1,00,000 80,000 60,000 -
Machine hours per unit (B) 3 4 5 -
Machine hours (A B) 3,00,000 3,20,000 3,00,000 9,20,000
Labour hours per unit (C) 6 4 3 -
Labour hours (A C) 6,00,000 3,20,000 1,80,000 11,00,000

73,60,000
Machine hour rate = = `8 per machine hour
9,20,000
55,00,000
Labour hour rate = = `5 per labour hour
11,00,000
Statement of profit
X Y Z Total
Production (units) (A) 1,00,000 80,000 60,000 2,40,000
Selling price per unit (B) 90 180 140 -
Sales (C = A B) 90,00,000 1,44,00,000 84,00,000 3,18,00,000
Direct cost per unit (D) 50 90 95 -
Total Direct Cost (A D) 50,00,000 72,00,000 57,00,000 1,79,00,000
Overheads:
Machine department 3,00,000 × 8 3,20,000 × 8 3,00,000 × 8 73,60,000
cost = 24,00,000 = 25,60,000 = 24,00,000
Labour department cost 6,00,000 × 5 = 3,20,000 × 5 = 1,80,000 × 5 55,00,000
30,00,000 16,00,000 = 9,00,000
Total Cost (E) 1,04,00,000 1,13,60,000 90,00,000 3,07,60,000
Profit (C – E) (14,00,000) 30,40,000 (6,00,000) 10,40,000
(b) Calculation of cost Driver Rate
Cost pool Amount (`) Cost Driver Quantity Cost Driver Rate (`)
Machining Services 64,40,000 9,20,000 Machine hours `7 per machine hour
Assembly Services 44,00,000 11,00,000 direct labour `4 per labour hour
hours
Set-up costs 9,00,000 9,000 Machine set-ups `100 per machine set-up
Order processing 7,20,000 7,200 Customer orders `100 per order
Purchasing 4,00,000 800 Purchase order `500 per purchase order

Activity Based Costing 211

 Statement of profit
X Y Z Total
Production (units) (A) 1,00,000 80,000 60,000 2,40,000
Selling price per unit (B) 90 180 140 -
Sales (C = A B) 90,00,000 1,44,00,000 84,00,000 3,18,00,000
Direct cost per unit (D) 50 90 95 -
Total Direct Cost (A D) 50,00,000 72,00,000 57,00,000 1,79,00,000
Overheads:
Machining services 3,00,000 7 3,20,000 7 3,00,000 7 64,40,000
= 21,00,000 = 22,40,000 = 21,00,000
Assembly services 6,00,000 × 4 3,20,000 × 4 1,80,000 × 4 44,00,000
= 24,00,000 = 12,80,000 = 7,20,000
Machine set-up costs 4,500 × 100 3,000 × 100 1,500 × 100 9,00,000
= 4,50,000 = 3,00,000 = 1,50,000
Order processing cost 2,200 × 100 2,400 × 100 2,600 × 100 7,20,000
= 2,20,000 = 2,40,000 = 2,60,000
Purchasing cost 300 × 500 350 × 500 150 × 500 4,00,000
= 1,50,000 = 1,75,000 = 75,000
Total Cost (E) 1,03,20,000 1,14,35,000 90,05,000 3,07,60,000
Profit (C – E) (13,20,000) 29,65,000 (6,05,000) 10,40,000

18.
(a) Statement of operating income
Particulars Market S Market K Market M Total
Revenue per delivery 84,975 28,875 5,445 -
No. of delivery 330 825 2,750 -
Revenue (A) 2,80,41,750 2,38,21,875 1,49,73,750 6,68,37,375
COGS 82,500×330 27,500 825 4,950 2,750 6,35,25,000
=2,72,25,000 =2,26,87,500 =1,36,12,500
Gross Margin (B) 8,16,750 11,34,375 13,61,250 33,12,375
(-) Operating cost - - - 8,27,970
Net Income - - - 24,84,405
Gross Margin (B A) 2.91 4.76 9.09 4.96

212 Cost and Management Accounting PW

 (b) Statement of Cost
Particulars Cost (`) (A) Cost Driver (B) Cost per cost driver
(A÷B)
Customer purchase 2,20,000 5,500 orders `40 per order
order
Line item ordering 1,75,560 58,520 line items `3 per line item
Store delivery 1,95,250 3,905 delivery `50 per delivery
Cartons dispatched 2,09,000 2,09,000 cartons `1 per carton
Shelf-stocking 28,160 1,760 hours `16 per hour

(c) Statement of operating income

Particulars Market S Market K Market M
Gross Margin (A) 8,16,750 11,34,375 13,61,250
From (a) part
Customer purchase 40×385 = 15,400 990×40 = 39,600 4,125×40 = 1,65,000
order cost
Line item ordering cost 3×14×385 3×12×990 3×10×4,125
= 16,170 = 35,640 = 1,23,750
Store delivery cost 50×330 = 16,500 50×825 = 41,250 50 2,750 = 1,37,500
Cartons dispatch cost 1×300×330 1×80×825 1 16 2,750 = 44,000
= 99,000 = 66,000
Shelf-stocking cost 16×3×330 16 0.6 825 16 0.1 2,750 = 4,400
= 15,840 = 7,920
Operating cost (B) 1,62,910 1,90,410 4,74,650
Net income (A – B) 6,53,840 9,43,965 8,86,600

Activity based costing shows that Market M uses the large amount of SK Ltd.’s operating cost
resources than the other two channels.

19.
(i) (a) Statement of operating income
Particulars Drug A Drug B Drug C Total
Revenue (A) 74,50,000 1,11,75,000 1,86,25,000 3,72,50,000
COGS 41,44,500 68,16,750 1,20,63,750 2,30,25,000
Gross Margin 33,05,500 43,58,250 65,61,250 1,42,25,000
(-) Operating cost (in COGS Ratio) 16,57,800 27,26,700 48,25,500 92,10,000
Operating Income (B) 16,47,700 16,31,550 17,35,750 50,15,000
Operating income (B A) 22.12 14.60 9.32 13.46

Activity Based Costing 213

 (i) (b) Statement of Cost

Particulars Cost (`) (A) Cost Driver (B) Cost per cost driver (A÷B)
Ordering 8,30,000 2,000 purchase order `415 per purchase order
Delivery 18,20,000 2,800 deliveries `650 per delivery
Shelf stocking 32,40,000 4,500 hours of shelf `720 per hour of shelf stocking
stocking time time
Customer support 28,20,000 4,70,000 units sold `6 per unit sold

Statement of operating income

Particulars Drug A Drug B Drug C
Revenue (A) 74,50,000 1,11,75,000 1,86,25,000
COGS 41,44,500 68,16,750 1,20,63,750
Gross Margin (B) 33,05,500 43,58,250 65,61,250
Drug License Fee (in 2:3:5) 1,00,000 1,50,000 2,50,000
Ordering cost 415 × 560 = 2,32,400 415 × 810 = 3,36,150 415 × 630
=2,61,450
Delivery cost 650 × 950 = 6,17,500 650 ×1000 = 6,50,000 650 × 850
= 5,52,500
Shelf Stocking cost 720 × 900 = 6,48,000 720 ×1250 = 9,00,000 720 ×2350
= 16,92,000
Customer support 6 × 175200 = 6 × 150300 = 9,01,800 6 × 144500
10,51,200 = 8,67,000
Operating cost (C) 26,49,100 29,37,950 36,22,950
Operating income (B – C = D) 6,56,400 14,20,300 29,38,300
Operating income % (D÷A) 8.81 12.71 15.78

(ii) When the operating costs are distributed on the basis of cost of goods sold, Drug A has
the highest level of operating income percentage because lesser operating cost share is
distributed to it.
Activity based costing shows that Drug C uses the large amount of operating cost resources
than the other two drugs and simultaneously generates the highest level of revenue and thus
operating income percentage is maximum in case of Drug C.



214 Cost and Management Accounting PW