Activity based costing examples

Example: 1 A company manufactures two products X and Y.The Product X is a low- volume and its sales are only 5000 units p.a.Product Y is highvolume, its sales are are 25000 units p.a.Product X takes 6 labor hours to make one unit, but Product Y requires 8 hours per unit. Details of costs for materials and labor for each product are: Particulars Direct materials Direct labor(@Rs.10 per hour) product x 200 60 260 product y 100 80 180 Rs

The company works 100000 direct labour hours p.a. Total manufacturing overhead costs Rs.1750000p.a. You are required to compute per unit cost of each product using: (a) Direct labour hour rate method for absorption of overhead costs, and (b) ABC technique for absorption of overhead costs.

Solution (A) Computation of product costing using direct labour hour rate method Overhead cost per our = Total manufacturing overhead /total direct labuor hour =Rs. 1750000/100000 D.L.H Rs. 17.50 Manufacturing overhead Product X Product Y =Rs. 17.50xD.L.H. =Rs 17.50x 8 D.L.H =Rs. 105 =Rs. 140

Activity based costing approach

Step1: ascertain the major activates or events and determine overhead rates for each activity

Activity

total overheads

frequency

rate per activity 45 per setup 20 per Inspection 300 per order 12.5 hour 130 per receipt

(Traceable costs) of activity Machine setup Quality inspection Production order Machine hours worked Material receipts Total overheads 450000 300000 180000 625000 195000 1750000 10000 15000 600 50000 1500

Step:2 Allocate overheads to products on the basis of activity rates

Product x Activity frequently activity Machine setup Quality inspection 10000 15000 rate per activity 45 20 300 12.5 130 activity frequency amount (Rs.) 4000 5000 400 38000 1200 activity frequency amt.

product y

6000 270000 10000 200000 200 12000 300 60000 150000 39000 719000 5000 143.80

180000 100000 120000 475000 156000 1031000 25000 41.24

Productive order 600 Machine hours worked 50000 Material receipts 1500 Total overhead cost Total number of units produced Overhead cost per unit

Computation of Total Cost under Both Methods (RS.)

Particulars Product x Direct material Direct labour Manufacturing overhead Total cost of manufacture 20000 60.00 143.80 403.80

ABC technique product y 100.00 80.00 41.24 221.24

Traditional method Product x 200 60 105 365 Product y 100 80 140 320

Example:2 ABC Ltd. Manufactures two types of machinery equipments Y and Z and applies/absorbs overheads on the basis of direct labour hours. The budgeted overheads and direct labour hours for the month of December,2009 are Rs. 1242500 and 20000 hours respectively.The information about Companys products is as follows:

Particulars Budgeted production volume Direct material cost Direct labour cost:Y (3 hours @ Rs.150 p.h.) X (4 hours @ Rs.150 p.h.)

Equipment Y 2500 units Rs.300 p.u. Rs.450 _

Equipment Z 3125 units Rs.450 p.u. _ Rs.600

ABC Ltds overheads of Rs. 1242500 can be identified with three major activities:

Order processing (Rs. 210000), machine processing (Rs. 875000),and product inspection (Rs.157500).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:

Orders processed

machine hours worked

inspection hours

Y Z Total Required: (i)

350 250 600

23000 27000 50000

4000 11000 15000

Assuming use of directlabour hours to absorb/ apply overheads to production,compute the unit manufacturing cost of the equipments Y and Z,if the budgeted manufacturing volume is attained. (ii) Assuming use of activity based costing, compute the unit manufacturing costs of the equipments y and , if the budgeted manufacturing volume is achieved. (iii) ABC 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. (iv) Discuss, how an Activity Based costing might benefit ABC ltd.

Solution: (i) Computation of unit manufacturing cost using Direct Labour hours to absorb overheads to production Direct labour hour rate =Rs.1242500/20000 D.L.H.=Rs.62.125 per D.L.H. (Rs.) Particulars Direct material p.u. Direct labour cost p.u. Prime cost p.u. Add:overheads Total cost p.u. (3hrs.xRs. 62.125);(4 hrs. x Rs. 62.125) Y 300.00 450.00 750.00 186.38 936.38 Z 450.00 600.00 1050.0 248.50 1298.50

(ii)

Computation of unit manufacturing cost using Activity Based Costing Segregation of budgeted overheads

(a)Order processing Y = (Rs.210000x350/600)/2500 units Z =(Rs.210000x250/600)/3125 units (b)Machine processing Y = (Rs. 875000x23000/50000)/2500units Z =((Rs. 875000x27000/50000)3125units (c)Product inspection Y = (Rs.157500x4000/15000)/2500 units Z= (Rs.157500x11000/15000)/3125units = Rs. 16.80 p.u. =Rs. 36.96 p.u. (Rs.) Particulars Direct material p.u. Direct labour cost p.u Prime cost p.u. Y 300.00 450.00 750.00 Z 450.00 600.00 1050.00 =Rs.161p.u. =Rs.151.20p.u. =Rs. 49 p.u. =Rs. 28p.u.

Add:budgeted overheads p.u. Order processing Machine processing Product inspection Total cost p.u. 49.00 161.00 16.80 226.80 976.80 28.00 151.20 36.96 216.16 1266.16

(iii) Statement showing difference in cost p.u. Particulars Total cost p.u. (a) Under Activity based costing method (b)Under direct labour hour rate method Over stated /(under stated) 976.80 936.38 (40.42) 1266.16 1298.50 32.34 y z

(iv)The absorption of overheads under activity based costing helps in ascertainment of product cost nearest to the cost incurred, since the activities that apportionment of overheads relates the activities that bring out the production.There will be least cost distortion if ABC method is used instead of blanket absorption rate i.e.direct labour hour rate of overhead absorption .

Example 3: XYZ ltd. Produces and sells sophisticated glass itens a and b . in connection with both the products the following informations are revealed from the cost records for the month February , 2009: Product Output (in units) Sales(Rs.) Cost structure: Direct material (Rs. Per unit) Direct wages (Rs. Per unit ) Direct labour hours 18.75 10.00 30000 hours 45.00 13.00 9750 hours A 60000 B 15000

No. of quantity produced per batch Steup time per batch The indirect costs for the month are as under. Cleaning and maintenance wages Designing costs Set up costs Manufacturing operations costs Shipment costs Distribution costs Factory administration costs

240 2 hours

50 5 hours (Rs) 270000 450000 300000 637500 81000 391500 255000

At present the company adopts the policy to absorb indirect costs applying direct labour hour basis ands enjoying a good position in the market with regard to product B,but facing a stiff price competition with regard to product A. the cost accountant of the company, after making a rigours analysis of the data, decided to to shift from the absorption technique based on direct labour hours to activity cost driver basis and also to treat cleaning and maintenance wages as direct cost.

The cost accountant identified Rs.120000 for product A and the balance of cleaning and maintenance wages fopr product B. The data revelant to activites and products are as follows;

Activity Designing Manufacturing operations Shipment Distribution Setup of moulding machie Favtory administration You are required (i) (ii)

cost driver square feet moulding machine hours number of shipment cubic feet setup hours direct labour hours

product A 30 sq. feet 9000 hours 100 45000 cu ft.

product B 70 sq. feet 3750 hours 100 22500 cu ft.

To compute the total manufacturing costs and profits of the products by applying direct labour basis of absorption, assuming cleaning and maintenance costs as indirect, To compute the total manufacturing cost andf profits of both the both products by applying activity based costing, assuming cleaning and maintenance cost as indirect.

(iii) To compare the results obtained from (i)and (ii) and give your opnion on th decision cost accountant . Solution Total direct labor hours = 30000+9750=39750 hours Calculation of total indirect costs Cleaning and maintenance wages Designing costs Setup costs Manufacturing operations costs Shipment cost Factory administration costs Total indirect costs (Rs.) 2750000 450000 300000 637500 81000 255000 2385000

Overhead absoption rate = Rs 2385000/39750hrs. (i) Computation of total manufacturing costy and profits of both the products by applying direct labour basis of absorption

Particulars

product A 60000 units Per unit amount (Rs) (Rs) 1125000 600000 17525000

product B 15000 units per unit (Rs) 45.00 13.00 58.00 amount (Rs) 675000 195000 8700000

Total

Direct materials Direct labors Prime cost Indirect costs

18.75 10.00 28.75

1800000 795000 2595000

(30000 hrs x Rs 60) (9750 hrs x Rs. 60) 30.00 Total cost Profit(balancing figure) sales . 58.75 4.25 63.00

1800000 3525000 255000 3780000

39.00 97.00 40.00 137.00

585000 1455000 600000 2055000

2385000 4980000 855000 5835000

(ii)Computation of total manufacturing cost and the profits of both the products applying ABC (a)Cleaning and maintenance wages (direct labour hour basis) =Rs.270000/39750 DLH Product A=30000 DLH*Rs. 607925 Product B=9750 DLH *Rs. 607925 (b)designing costs (square feet basis)r =Rs.450000/100sq.feet Product A=30.feet *Rs. 4500 Product B=70 sq feet *Rs. 4500 (c)setup costs (setup hours basis) =Rs. 300000/2000 hrs. Product A=500hrs.*Rs. 150 Product B=1500 hrs.*Rs. 150 =Rs. 150 per hr. =Rs. 75000 =Rs. 2250000 =Rs. 4500 per sq. feet =Rs. 135000 =Rs. 315000 =Rs. 6.7925per DLH =Rs. 203775 =Rs. 66225

(d)Manufacturing Operations Costs(moulding machine hours basis) = Rs. 637500/12750hrs. Product A Product B = 9000 hrs. x Rs.50 = 3750 hrs. x Rs.50 = Rs. 50 per MMH = Rs. 450000 =Rs.187500

(e)Shipment Costs (No. of shipment basis) =Rs.81000/200shipments Product A = 100 shipment x Rs.405 Product B = 100 shipment x Rs.405 =Rs. 405 per shipment = Rs. 40500 = Rs. 40500

(f)Distribution Costs (area in cibic feet basis) =Rs. 391500/67500 cubic feet Product A = RS.45000 cubic feet x Rs.5.80 Product B = RS.22500 cubic feet x Rs.5.80 =Rs. 5.80 per cubic feet =Rs.261000 =Rs.130500

(g) Factory Administration Costs(direct labour hours basis) =Rs.255000/39750 DLH Product A = 30000 DLH X Rs.6.4151 Product B= 9750 DLH X Rs.6.4151 =Rs.6.4151 DLH =Rs.192453 =Rs.62547 (Rs.) total

Computation of Product Cost and Profit by applying Activity Based Costing Particulars Product A 60000 units Per unit (Rs) Direct materials Direct labour Cleaning and maintenance Expences prime cost (a) 2.00 30.75 120000 1845000 10.00 68.00 150000 1020000 18.75 10.00 amount (Rs) 1125000 600000 product B 15000 units per unit (Rs) 45.00 13.00 amount (Rs) 675000 195000

1800000 795000

270000 2865000

Indirect Costs: Designing costs Setup Costs Manufacturing operation cost Shipment costs Distribution costs Factory administration costs Total indirect costs(b) Total costs(a) + (b) Profit (balancing figure) Sales 2.25 1.25 7.50 0.68 4.35 3.21 19.24 49.99 135000 75000 450000 40500 261000 192453 1153953 2998953 21.00 15.00 12.50 2.70 8.70 4.17 64.07 315000 450000 225000 300000 187500 637500 40500 81000 130500 391500 62547 255000 961047 2115000

132.07 1981047 4980000 4.93 73953 855000

13.01 781047 63.00 3780000

137.00 2055000 5835000

Note:Cleaning and maintenance expenses have been taken on direct basis as per the Cost Accountants observation.

(iii)Computation of Results obtained from(i) and(ii) Particulars Product A DLH Basis Pime cost Indirect costs Total costs Profit Selling price 28.75 30.00 58.75 4.25 63.00 ABC basis 30.75 19.24 49.99 13.01 63.00 Product B DLH ABC basis basis 58.00 68.00 39.00 97.00 40.00 64.07 132.07 4.93

137.00 137.00

Compiled by: Honey Sidhani Section:A Roll no.32