ACTIVITY BASED COST MANAGEMENT

1.

ABC Company produces two types of stereo units. Activity data follows:
Product-costing data
Activity usage measures
Deluxe
Regular
Units produced per year
5,000
50,000
Prime costs (Rs.)
39,000
3,69,000
Direct Labour hours
5,000
45,000
Machine hours
10,000
90,000
Production runs
10
5
Number of moves
120
60

Total
55,000
4,08,000
50,000
1,00,000
15
180

Activity Cost Data (overhead activities)

Activity

Activity cost (Rs.)

60,000
30,000
50,000
40,000
1,80,000

Setting up equipment
Material handling
Using power
Testing
Total

Required:
i)
Calculate the consumption ratios for each activity.
ii)
Group activities based on the consumption ratios and activity level.
iii)
Calculate a rate for each pooled group of activities.
iv)
Using the pool rates, calculate unit product costs.
2.

ABC company has been incurring two types of overhead costs- material handling and quality
inspection. The costs expected for these categories for the coming year are as follows:
Material handling
Quality inspection

Rs.
Rs.

10,00,000
30,00,000

The company currently charges overhead using direct labour hours and expected actual capacity.
This figure is 50,000 direct labour hours.
The factory manager has been asked to submit a bid and has assembled the following data
concerning the proposed job.
Job
Direct Materials
Rs.
37,000
Direct labour (1,000 hours)
Rs.
70,000
Number of material moves
10
Number of inspections
5
The manager has been informed that many competitors use an ABC approach to assign overheads
to jobs. Before submitting his bid for the proposed job, he wants to assess the effects of this
alternative approach. He estimates that the expected number of material moves for all jobs
during the year is 1,000. He also expects 5,000 quality inspections to be performed.
Required:
i) Compute the total cost of the proposed job using direct labour hours to assign overhead.
Assuming the bid price is full manufacturing cost plus 25%, what would be the

managers bid?
ii) Compute the total cost of the job using the number of material moves to allocate materialhandling costs and the number of inspections to allocate the quality inspections costs.
Assume bid price is full manufacturing costs plus 25%. What should be his bid using
this approach?
iii)
Which approach do you think best reflects the actual cost of the job? Explain

3.

A company produces four products P, Q, R, and S. The data relating to production activity are
as under:

Product

Quantity of
Production

Material
cost/Unit
Rs.

Direct
labour
hours/Unit

P
1,000
10
1
Q
10,000
10
1
R
1,200
32
6
S
14,000
34
1
Production overheads are as under:
i)
Overheads applicable to machine oriented activity
ii)
Overheads relating to ordering materials
iii)
Set up costs
iv)
Administration overheads for spare parts
v)
Material handling costs

Machine
hours/Unit

0.50
0.50
2.00
3.00
:
:
:
:
:

Direct
labour
cost/hour
(Rs).
6
6
4
18

Rs. 1,49,700
Rs.
7,680
Rs. 17,400
Rs. 34,380
Rs. 30,294

The following further information have been compiled:

Product
P
Q
R
S
Required:
i)
ii)

No. of
Set ups
3
18
5
24

No. of
Materials
Orders
3
12
3
12

No. of times
materials
Handled
6
30
9
36

No. of spare
Parts
6
15
3
12

Select a suitable cost driver for each item of overhead expense and calculate the
cost per unit of cost driver.
Using the concept of activity based costing, compute the factory cost per unit of
each product

4.

Relevant data relating to a company are:

Products
Particulars
Production and sales (Units)
Raw materials usage in units
Raw material costs
Direct labour hours
Machine hours
Direct labour costs
No. of production runs
No. of deliveries
No. of receipts
No. of production orders
Overheads

P
60,000
10
Rs. 50
2.5
2.5
Rs. 16
6
18
60
30

Q
40,000
10
40
4
2
24
14
6
140
20

R
16,000
22
22
2
4
12
40
40
880
50

Total

60
64
1080
100

Rs.
Set-ups
60,000
Machines
15,20,000
Receiving
8,70,000
Packing
5,00,000
Engineering
7,46,000
The company operates a JIT inventory policy and receives each component once per production
run.
Required:
1. Compute the product cost based on direct labour-hour recovery rate of overheads.
2. Compute the product costs using activity based costing.
5.

Having attended a CIMA course on activity-based costing (ABC) you decide to experiment by
applying the principles of ABC to the four products currently made and sold by your company.
Details of the four products and relevant information are given below for one period:
Product
A
B
C
D
Output in units
120
100
80
120
Costs per unit
(Rs.)
(Rs.)
(Rs.)
(Rs.)
Direct material
40
50
30
60
Direct labour
28
21
14
21
Machine hours (per unit)
4
3
2
3
The four products are similar and are usually produced in production runs of 20 units and sold
in batches of 10 units.
The production overhead is currently absorbed by using a machine hour rate, and the total of the
production overhead for the period has been analysed as follows:
(Rs.)
Machine department: costs (rent, business rates, depreciation, and supervision)
10,430
Set-up costs
5,250
Stores receiving
3,600
Inspection/Quality control
2,100
Materials handling and dispatch
4,620
You have ascertained that the cost drivers to be used are as listed below for the overhead costs
shown:
Cost
Cost Driver

Set-up costs
Number of production runs
Stores receiving
Requisitions raised
Inspection/Quality control
Number of production runs
Materials handling and dispatch
Orders executed
The number of requisitions raised on the stores was 20 for each product and the number of
orders executed was 42, each order being for a batch of 10 of a product. You are required
i)
ii)
iii)

6.

To calculate the total costs for each product if all overhead costs are absorbed on a
machine hour basis.
To calculate the total costs for each product, using activity-based costing.
To calculate and list the unit product costs from your figures in (i) and (ii) above, to
show the difference and to comment briefly on any conclusions which may be
drawn which could have pricing and profit implication

The following budgeted information relates to Brunti PLC for the forthcoming period:
Products

Sales and production (units)

Selling price (per unit) (Rs.)
Prime cost (per unit) (Rs.)
Machine department
(Machine hours per unit)
Assembly department
(Direct labour hours per unit)

XYI

YZT

ABW

50,000
45
32
Hours
2

40,000
95
84
Hours
5

30,000
73
65
Hours
4

Overheads allocated and apportioned to production departments (including service cost centre
costs) were to be recovered in product costs as follows:
Machine department at Rs. 1.20 per machine hour.
Assembly department at Rs. 0.825 per direct labour hour.
You ascertain that the above overheads could be re-analysed into cost pools as follows:
Cost pool

Machining services
Assembly services
Set-up costs
Order processing
Purchasing

Rs. 000

357
318
26
156
84
941

Cost driver

Quantity
for the
period
4,20,000
5,30,000
520
32,000
11,200

Machine hours
Direct labour hours
Set-ups
Customer orders
Suppliers orders

You have also been provided with the following estimates for the period:
Products
XYI
Number of set-ups
Customer orders1
Suppliers order

YZT
120
8,000
3,000

ABW
200
8,000
4,000

200
16,000
4,200

Required:
Prepare and present profit statements using:
i) Conventional absorption costing;
ii) Activity-based costing.
7.

XYZ Plc manufactures four products, namely A, B, C, and d, using the same plant and processes.
The following information relates to a production period:

Product
A
B
C
D

Volume
500
5000
600
7000

Material
Cost per unit
(Rs.)
5
5
16
17

Direct
Labour hour
per unit
hour
hour
2 hours
1 hours

Machine
Time per
unit
hour
hour
1 hour
1 hours

Labour
Cost per unit
(Rs.)`
3
3
12
9

Total production overhead recorded by the cost accounting system is analysed under the following
headings:
Factory overhead applicable to machine-oriented activity is Rs. 37,424.
Set-up costs are Rs. 4,355
The cost of ordering materials Rs. 1,920
Handling materials Rs. 7,580
Administration for spare parts Rs. 8,600.
These overhead costs are absorbed by products on a machine hour rate of Rs. 4.80 per hour,
giving an overhead cost per product of:
A= Rs. 1.20
B=Rs. 1.20
C= Rs. 4.80
D= Rs. 7.20
However, investigation into the production overhead activities for the period reveals the following
totals:
Number of
Number of
Times
Number of
Product
Number of
Material
Material was
Spare
Set-ups
Orders
Handled
parts
A
1
1
2
2
B
6
4
10
5
C
2
1
3
1
D
8
4
12
4
You are required:
i)
To compute an overhead cost per product using activity- based costing, tracing overheads
to production units by means of cost drivers.
ii)
To comment briefly on the difference disclosed between overheads traced by the present
system and those traced by activity based costing.

H manufactures three parts fuel systems, transmission assemblies and electrical system. For the
past five years manufacturing overhead has been applied to products on standard direct labour
hours for the units actually produced. The standard cost information is shown below.
The current direct labour rate is Rs 10 per hour. New machinery that automates the production
process was installed two years ago and greatly reduced the direct time to produce the three
products. The selling price for each of the three products is 125% of the manufacturing costs.
Hs segment has become very competitive and the companys profits have been decreasing. J the
financial controller has been asked by the president of the company to analyse the overhead
allocation and price structuring. J thinks that future allocation should be based on machine

hours and direct labour hours rather than the current allocation method, which is based on
direct labour hours only.
B has determined the additional product information as shown below:
Standard cost information
Fuel systems

Units produced and sold

Standard labour hours
Standard direct material cost per unit
Budgeted and actual manufacturing
overhead

10,000
2.0
25.00

Transmission
assembly

20,000
1.50
36.00
Rs 39,20,000

Electrical system

30,000
1.0
30.00

Additional product information

Fuel systems

Transmission
assemblies

Electrical systems

Standard machine hours

2.0
4.0
6.0
Manufacturing overhead
Direct labour hours
5,60,000
Machine hours
33,60,000
Required:
i)
By allocating the entire budgeted overhead based on direct labour hours, calculate the
unit manufacturing cost and unit sales price for each of the three products manufactured
at H Company.
ii)
Prepare an analysis for H Company using appropriate cost drivers determined by J for
manufacturing overhead. Calculate the unit manufacturing cost and unit sales price for
each of the three products.
iii)
Based on the calculations in requirements 1 and 2 above prepare a recommendation for
the president to increase the firms profitability.
9

R company sells craft kits and supplies to retail outlets and through its catalogue. Some of the
items are manufactured by R while others are purchased for resale. For the products it
manufactures, the company currently bases its selling price on a standard costing system that
accounts for direct materials, direct labour and the associated overhead costs. In addition to
these standard product costs, R incurs substantial selling costs and R financial controller has
suggested that these selling costs should be included in the product pricing structure.
After studying the costs incurred over the past two years for one of its products skeins of knitting
yarn, J has selected four categories of selling costs and developed cost drivers for each of these
costs. The selling cost actually incurred during the past year and the cost drivers are shown
below:
Cost category
Amount
Cost driver
Sales commissions
6,75,000 Boxes of yarn sold to retail stores
Catalogues
2,95,400 Catalogues distributed
Cost of catalogue sales
1,05,000 Skeins sold through catalogue
Credit and collection
60,000 Number of retail orders
11,35,400
The knitting yarn is sold to retail outlets in boxes, each containing twelve skeins of yarn; the sale
of partial boxes is not permitted. Commissions are paid on sales to retail outlets but not on
catalogue sales. The cost of catalogue sales includes the wages of personnel who take the
catalogue orders and telephone costs. J believes that the selling costs vary significantly with the
size of the order; order sizes are divided into three categories as shown later.
Order size
Catalogue sales
Retail sales
Small
1-10 skeins
1-10 boxes
Medium
11-20 skeins
11-20 boxes
Large
Over 20 skeins
Over 20 boxes

An analysis of the previous years records produced the statistics shown in the chart below:
Order size
Small
Medium
Large
Total
Retail sales in boxes (12 skeins
2,000
45,000
1,78,000
2,25,000
per box)
Catalogue sales in skeins
79,000
52,000
44,000
1,75,000
Number of retail orders
485
2,415
3,100
6,000
Catalogue distributed
2,54,300
2,11,300
1,25,200
5,90,800
Define the concept of activity based costing and provide two examples of cost drivers that are not
related to selling costs.
Prepare a detailed schedule showing R companys total selling cost for each order size and the per
skein selling cost within each order size.
Explain how the analysis of the selling costs for skeins of knitting yarn is likely to impact future
pricing and product decisions at R company.
10

P company is a subcontractor that produces subassemblies, KS 26 and LF 16 used in

manufacturing trucks. P is currently using absorption-costing system that allocates overhead
based on direct labour. The budget for the current year ending December 31 st 1995 is shown
below:
M, Ps president has been reading about a new type of costing method called activity based
costing. M is convinced that activity based costing will cast a new light on future profits. As a
result, B accountant has accumulated cost pool information for this year shown on the chart
below. This information is based on a standard mix of 5,000 units of KS 26 and 5,000 units of
LF 16.
Budget 31st December 1995
Full absorption costing system
KS-26
LF-16
Total
Sales units
5,000
5,000
10,000
Sales
17,00,000
22,00,000
39,00,000
Beginning inventory
2,40,000
3,00,000
5,40,000
Add:
Direct material
10,00,000
17,50,000
27,50,000
Direct labour
1,85,185
92,593
2,77,778
Total manufacturing
5,44,025
2,72,013
8,16,038
overhead*
Total goods available
19,69,210
24,14,606
43,83,816
Less:
Ending inventory
2,40,000
3,00,000
5,40,000
Cost of goods sold
17,29,210
21,14,606
38,43,816
Gross margin
(29,210)
85,394
56,184
* Allocated on the basis of direct labour hours.
Machining
4,24,528
Assembly
2,16,981
Material handling
56,604
Inspection
1,17,925
Total
8,16,038
Cost pool information
31st December 1995
Cost pool
Activity
KS -26
LF-16
Direct labour
Direct labour hours
10,000
5,000
Machining
Machine hours
15,000
30,000
Assembly
Assembly hours
6,000
5,500

Material handling
Number of parts
5
10
Inspection
Inspection hours
5,000
7,500
In addition the following information is planned for the year ending 31st December 1996.
Units
KS -26
LF-16
Beginning inventory, finished
800
600
goods
Ending inventory, finished
700
700
goods
Sales
5,100
4,900
st
On 1 January 1996, P is planning to increase the prices of KS 26 to Rs 355 and LF 16 to Rs
455. Material costs are not expected to increase next year, but direct labour will increase by 8%
and all manufacturing overhead costs will increase by 65. Due to the nature of manufacturing
process. P does not have any beginning or ending work in progress inventories.
P uses a JIT inventory system for direct materials and has materials delivered to the production
facility directly from the vendors. The raw materials inventory both at the beginning and the end
of the month is immaterial and can be ignored for the purpose of th Proforma income statement.
P uses the FIFO method for valuing inventory.
Required:
Explain how activity based costing differs from traditional costing methods.
Prepare a pro-forma statement showing the operating margin of Plymouth company for the year
ending December 31st using activity based costing.