Activity Based Costing

Activity Based Costing
activity
based c osting
Determining Cost of an Object
Intuition
Educated Guessing
Conventional CA
Total Cost for a Cost Object
Direct Cost (Lab + Mat)

+ Overhead Cost
=Total Object Cost
CCA & ABC

Conventional Cost Accounting
Arbitrarily Apportion overhead to Cost Objects
Overhead Apportioned according to some basis
Overhead Absorbed to Products— lab hours, Machine Hrs
Assumption; Relation between Overhead &

Volume Based Measure
Conventional CostCosting
Activity Based Accounting
Departmentalization
1 Process of dividing the factory into number

of Segments Is called Departmentalization
P1 P2 P3 S1 S1
Prod Departments Service Dept.

Departmentalization
2 Process of allocating and apportioning POHEs to

different departments or
cost centers (Prod & Service ) Factory
Overheads
P1 P2 P3 S1 S1

Factory
Departmentalization Overheads
Allocation &
Apportionment
P1 P2 P3 S1 S1

Absorption
Service
Department
(Cafeteria) Operating
Department
Service (Machining)
The
Department
Products
(Accounting) Operating
Department
Service (Assembly)
Department
(Personnel)
CCA in an Organization…………….
Two Products A and Product B
Product A
I hour of Direct labour
Direct Labour Cost: 1hour x Rs 20= Rs 20
Production 100 units
Product B
2 hours of direct labour
Direct labour Cost:2 hours x Rs 20= Rs 40
Production=950 units
CCA in an Organization (Contd)…………….
Total Overhead =Rs 1,00,000

Total Direct Labour=2000 hours
OH Rate/hr=Rs 1,00,000/2000hours
=Rs 50/hour
Product A : 1 hour of direct labour
Product B: 2 hours of direct labour
CCA overhead allocation A: Rs 50 per unit

B: Rs100 per unit
CCA may lead to Under Costing & Over Costing
Under absorption -under pricing product
Over absorption - over pricing product

M Course Dessert Drinks Total

Rs Rs Rs Rs
Abhishek 110 0 40 150

Banke 200 80 140 420
Paraveen 150 40 80 270
Devinder 140 40 60 240
Total 600 160 320 1080
Average 150 40 80 270

What is noticeable in
distribution of Cost?
To avoid this
Ambiguity and
under/over absorption
of cost
ABC is a Good Alternative
Activity Based Costing -what is ABC?
ABC is a method that measures cost of a

Product/Service, based on the activities performed
to produce the product / service
Activity Based Costing -what is ABC?
An Activity is an event,
task or unit of work
with a specified purpose
Designing products
Setting up Machines
Operating Machines
Distributing Products
Administer Processes
Activity Based Costing System
Assigned to
Costs of
Activities
Activities
Cost Object
•Product
•Service
•Customer
According to use
When to use
When Overhead is High
Products are Diverse: complexity,
Cost of Error is High
Competition is Stiff
Activity Based Costing few features
More Accurate Cost Management Methodology
Focus on Indirect Costs (Overhead)
Traces rather than allocate each expense

category to the particular Cost Object
Makes “indirect” Expenses “Direct’

--Steps
1 Identify Activities
2 Determine Cost for Each Activity
3 Determine Cost Drivers
4Calculate Activity Rate
5 Assign Cost To Cost Object

--Steps
1 Identify Activities
Set –UP
Machining
Receiving
Packing
Engineering
--Steps
2 Determine Cost for Each Activity
Set Up- Rs 10,000
Machining - Rs40,000
Receiving- Rs10,000
Packing - Rs 10,000
Engineering- Rs 30,000
--Steps
3 Determine Cost Drivers
Setup — Number of Setups
Machining —Machine Hours
Receiving – No. of Receipts
Packing —No. of Deliveries
Engineering —No of Hours

--Steps
4Calulate Activity Rate
Activities Cost Prod A COST Prod B Cost

Rs Rs Rs
Set Up 10,000 1no 2500 3no 7500
Machining 40,000 100Hrs 2000 1900Hrs 38000
Receiving 10,000 1 no 2500 3 no 7500
Packing 10,000 1 2500 3 7500

Engineering 30,000 500Hrs 15000 500
Hrs 15000
1,00,000 24,500 75,500

--Steps
5 Assign Cost to Cost Object
Overhead for Product A
Rs 24,500: 100=Rs245
Overhead for Product B
Rs 75,500: 950=Rs79.47
Total Overhead =Rs 1,00,000

Total Direct Labour=2000 hours
Rs 1,00,000/2000hours =Rs 50/hour
Product A : 1 hour of direct labour

Product B: 2 hours of direct labour
CCA overhead allocation A: Rs 50 per unit

B: Rs100 per unit
Product Cost CCA & ABC…
Cost Of Product A Cost Of Product B
CCA ABC CCA ABC

Rs Rs Rs Rs
Overhead 50 245 O’head 100 79.47
D Cost 20 20 D Cost 40 40.00
Total 70 265 Total 140 119.47
Overhead Under absorbed Overhead Over absorbed

How the company should react to this situation?

Distribute Case-dell computer

1Why did Dell use cross Functional employee teams

to identify company Activities?
2What would Dell have risked--------
3 Dell focused on 10 activities………

Activity Based Costing question
Direct Lab Work

Sales Direct Lab Hrs 12 Support Staff
Two Products 4,00,000 DLH
A-1000 A-1 hour Over Head
A&B Per periods
B-25000 B-.60hour
B-.60 hour RS 5,00,000
Support Staff Engaged in 3 activities
6 engaged in receiving 25000 consignments of components

3 engaged in receiving 10000 consignments of Raw Materials
3 engaged in disbursing kits of components & materials for
5000 production runs
duct A Requires Product B
0 Consignments of Components 100 Consignments of Components

Consignments of Raw Materials 8 Consignments of Raw Materials
Production runs per period 5 Production runs per period
Activity Based Costing ABC question
You are required to-
a) Calculate OH Cost of products A& B using CCA

b) Identify appropriate cost drivers & calculate the
Over Head Cost of A& B using ABC
c) Compare answers of A & B
Activity Based Costing ABC Solution
A) CCA
Total Overhead Cost =Rs 5,00,000
Total Direct Lb. Hours= 4,00,000
OH Rate Per Lab Hr =5,00,000/4,00,000
= Rs 1.25 per hour
Products Per Unit Total

(Rs) Rs
A (1XRS 1.25) 1.25 1000x1.25=Rs1250
B (.6XRs 1.25) 0.75 25000x .75=Rs18750
B)
Appropriate Cost Activities
1) Receiving Components
2) Receiving Raw Materials
3) Disbursing Kits of RM & Components

Activity Based Costing Solution
B)
Cost Of Activities
Receiving Components =Rs2,50,000 (500000x6/12)
Receiving Raw Materials=Rs1,25,000
Disbursing R Mat.& Kits = Rs1,25,000

duct A Requires Product B
0 Consignments of Components 100 Consignments of Components

Consignments of Raw Materials 8 Consignments of Raw Materials
Production runs per period 5 Production runs per period
B) OVERHEAD Charging to Product Cost
Products Overhead Allocation Total (Rs) Per Unit (Rs)
A (200X10+50X12.50+10X25) 2,875 2.87
B (100X10+8X12.50+5X25 ) 1,225 0.05

Comparison
Products Total (Rs) Diff Per Unit (Rs)

ABC CCA ABC CCA Diff
A) 2,875 1250 1625 2.87 1.25 1.62
B) 1,225 18750 17525 0.05 0.75 .70

C) Comparison of Two Methods
1) Product cost shown in B are more meaningful than in A)
2) CCA is more of an estimation
3) ABC is more accurate, clear and scientific

Activity Based Costing Question -2
A Company produces 3 products, the costs of which are as follows

A(Rs) B(Rs) C(Rs)
Direct Materials 50 40 30
D Labour(Rs10/Hr) 30 40 50
Production Overhead 30 40 50
Total Cost/per unit 110 120 130
Quantity Produced(units) 10000 20000 30000
Overhead are absorbed on the basis of labour hours.
The Company wishes to introduce ABC and has identified two

major cost pools for production overhead and their association
cost drivers
Activity Based Costing Question -2
Activity Cost Pool Cost Driver Cost Of Activities
Receiving/Inspecting/Quality Assurance Purchase Requisition Rs 14,00,000
Production Scheduling/Machine Setups Numbers Of Batches Rs 12,00,000
Further Information
A B C
No of Purchase Requisitions 1200 1800 2000

Number of Setups 240 260 300
Calculate cost of ABC products under activity based costing

Compare it with CCA
Activity Based Costing Answer-2
Activities
Activities
Receiving
Production Scheduling
Inspecting
Machine Setups
Quality Insurance
No. of Batches
Purchase Requisition
Overhead=Rs14,00,000
Overhead = Rs12,00,000
Batches Setups = 800
P Requisitions=5000
Cost Per setups=
Cost per Req=
1200000/800
1400000/5000
=1500 per setup
=Rs 280 /PR
A B C
Receiving/inspecting/ quality 280 x1200 280 x1800 280x2000

10000 20000 30000
= Rs 33.60 Rs 25.20 =Rs 18.66
Prod Scheduling/M Setups 1500x240 1500x260 1500x300

10000 20000 30000
= Rs 36.00 Rs 19.50 Rs 15.00

A(Rs) B (Rs) C(Rs)
Direct Materials 50.00 40.00 30.00

Direct Labour 30.00 40.00 50.00
Production Overhead
a) Receiving/inspecting 33.60 25.20 18.66
b) Scheduling/Setups 36.00 19.50 15.00
Total Cost PU 149.60 124.70 113.66

Activity Based Costing SUMMARY
ABC is more accurate Cost Management

System than Traditional Cost System
CCA is unable to calculate True Cost of

A Product/Service
Activity Based Costing benefits
Pricing and Product Mix Decisions
Cost Reduction & Process Improvement

Decisions
Design Decisions
Planning & Managing Activities

Activity Based Costing limitations
May require Substantial Resources
Benefits must outweigh the additional Cost
May be difficult to apply in certain cases


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Activity Based Costing

Determining Cost of an Object

Total Cost for a Cost Object

Direct Cost (Lab + Mat)

CCA & ABC

Conventional Cost Accounting

Arbitrarily Apportion overhead to Cost Objects

Overhead Apportioned according to some basis

Overhead Absorbed to Products— lab hours, Machine Hrs

Assumption; Relation between Overhead &

1 Process of dividing the factory into number

Prod Departments Service Dept.

2 Process of allocating and apportioning POHEs to

Prod Departments Service Dept.

Prod Departments Service Dept.

Two Products A and Product B

CCA in an Organization (Contd)…………….

Total Overhead =Rs 1,00,000

CCA overhead allocation A: Rs 50 per unit

CCA in an Organization (Contd)…………….

CCA may lead to Under Costing & Over Costing

Under absorption -under pricing product

Over absorption - over pricing product

CCA in an Organization (Contd)…………….

M Course Dessert Drinks Total

Abhishek 110 0 40 150

Total 600 160 320 1080

Average 150 40 80 270

ABC is a method that measures cost of a

When Overhead is High

Products are Diverse: complexity,

Cost of Error is High

More Accurate Cost Management Methodology

Focus on Indirect Costs (Overhead)

Traces rather than allocate each expense

Makes “indirect” Expenses “Direct’

5 Assign Cost To Cost Object

2 Determine Cost for Each Activity

Set Up- Rs 10,000

3 Determine Cost Drivers

Setup — Number of Setups

Machining —Machine Hours

Receiving – No. of Receipts

Packing —No. of Deliveries

Engineering —No of Hours

4Calulate Activity Rate

Activities Cost Prod A COST Prod B Cost

Machining 40,000 100Hrs 2000 1900Hrs 38000

Receiving 10,000 1 no 2500 3 no 7500

Packing 10,000 1 2500 3 7500

1,00,000 24,500 75,500

5 Assign Cost to Cost Object

Overhead for Product A

CCA in an Organization (Contd)…………….

Total Overhead =Rs 1,00,000

Rs 1,00,000/2000hours =Rs 50/hour

Product A : 1 hour of direct labour

CCA overhead allocation A: Rs 50 per unit

Product Cost CCA & ABC…