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Activity Based Costing

activity
based c osting
Activity Based Costing

Determining Cost of an Object

• Intuition
•Educated Guessing
•Conventional CA
•Activity Based Costing
Activity Based Costing

Total Cost for a Cost Object

Direct Cost (Lab + Mat)


+ Overhead Cost
=Total Object Cost
Activity Based Costing

CCA & ABC


Activity Based Costing

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.


Activity Based Costing

Departmentalization

2 Process of allocating and apportioning POHEs to


different departments or
cost centers (Prod & Service ) Factory
Overheads

P1 P2 P3 S1 S1

Prod Departments Service Dept.


Activity Based Costing

Factory
Departmentalization Overheads
Allocation &
Apportionment

P1 P2 P3 S1 S1

Prod Departments Service Dept.


Activity Based Costing

Absorption
Service
Department
(Cafeteria) Operating
Department
Service (Machining)
The
Department
Products
(Accounting) Operating
Department
Service (Assembly)
Department
(Personnel)
Activity Based Costing

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
Activity Based Costing

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
Activity Based Costing

CCA in an Organization (Contd)…………….

CCA may lead to Under Costing & Over Costing

Under absorption -under pricing product

Over absorption - over pricing product


Activity Based Costing

CCA in an Organization (Contd)…………….

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


Activity Based Costing

What is noticeable in
distribution of Cost?
Activity Based Costing

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 Cost Object
Activities
Activities •Product
•Service
•Customer
According to use
Activity Based Costing 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’


Activity Based Costing --Steps

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

1 Identify Activities

Set –UP
Machining
Receiving
Packing
Engineering
Activity Based Costing --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
Activity Based Costing --Steps

3 Determine Cost Drivers

Setup — Number of Setups

Machining —Machine Hours

Receiving – No. of Receipts

Packing —No. of Deliveries

Engineering —No of Hours


Activity Based Costing --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


Activity Based Costing --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
Activity Based Costing

CCA in an Organization (Contd)…………….

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
Activity Based Costing

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


Activity Based Costing

How the company should react to this situation?


Activity Based Costing

Distribute Case-dell computer


Activity Based Costing

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

Product A Requires Product B

200 Consignments of Components 100 Consignments of Components


50 Consignments of Raw Materials 4 Consignments of Raw Materials
10 Production runs per period 5 Production runs per period
Activity Based Costing ABC question

You are required to-

c) Calculate OH Cost of products A& B using CCA


d) 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
Activity Based Costing ABC Solution

B)
Appropriate Cost Activities

3) Receiving Components

5) Receiving Raw Materials

7) 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


Activity Based Costing ABC Solution

B)
Cost driver
Receiving Components =Rs2,50,000/25000=Rs10 per Receipt

Receiving Raw Mat. =Rs1,25,000/10000=Rs 12.50 per Rec.

Disbursing Kits = Rs1,25,000/5000=Rs 25 per issue


Activity Based Costing ABC Solution
Product A Requires Product B

200 Consignments of Components 100 Consignments of Components


50 Consignments of Raw Materials 4 Consignments of Raw Materials
10 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


Activity Based Costing ABC Solution

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


Activity Based Costing ABC Solution

C) Comparison of Two Methods

• Product cost shown in B are more meaningful than in A)

• CCA is more of an estimation

• 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
Activity Based Costing Answer-2

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
Activity Based Costing Answer-2

A B C

a) Receiving/inspecting/ quality 280 x1200 280 x1800 280x2000


10000 20000 30000

= Rs 33.60 Rs 25.20 =Rs 18.66

b) Prod Scheduling/M Setups 1500x240 1500x260 1500x300


10000 20000 30000

= Rs 36.00 Rs 19.50 Rs 15.00


Activity Based Costing Answer-2

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


Activity Based Costing