Activity Based Costing

Activity Based Costing
activity
based
osting
Determining Cost of an Object
Intuition
Educated Guessing Conventional CA Activity Based Costing
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
Prod Departments
P3
S1
S1
Service Dept.

Departmentalization
2 Process of allocating and apportioning POHEs to different departments or Factory cost centers (Prod & Service )
Overheads
P1
P2
Prod Departments
P3
S1
S1
Service Dept.

Factory Overheads Allocation & Apportionment
Departmentalization
P1
P2
Prod Departments
P3
S1
S1
Service Dept.
Absorption
Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Operating Department (Machining) Operating Department (Assembly)
The Products

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 Rs Rs Abhishek Banke Paraveen Devinder Total 110 200 150 140 600 0 80 40 40 160 Drinks Rs 40 140 80 60 320 Total Rs 150 420 270 240 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
Activities
Costs of Activities
Assigned to Cost Object

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

1 Identify Activities
Set UP Machining Receiving Packing Engineering

2 Determine Cost for Each Activity
Set UpMachining ReceivingPacking -
Rs 10,000 Rs40,000 Rs10,000 Rs 10,000
Engineering-
Rs 30,000

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
Set Up Machining Receiving Packing Engineering
Cost Rs
10,000 40,000 10,000
Prod A
1no 100Hrs 1 no
COST Prod B Cost Rs Rs

2500 2000 2500 3no 1900Hrs 3 no 3 500 7500 38000 7500 7500 15000 75,500
10,000 1 2500 30,000 500Hrs 15000 1,00,000 24,500
Hrs

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 CCA ABC Rs Rs Overhead 50 245 D Cost 20 20 Total 70 265
Cost Of Product B
CCA ABC Rs Rs Ohead 100 79.47 D Cost 40 40.00

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

Direct Lab Hrs Sales Two Products A-1 hour A-1000 A&B B-.60 hour B-.60hour B-25000 Support Staff Engaged in 3 activities
question
12 Support Staff Over Head RS 5,00,000
Direct Lab Work 4,00,000 DLH Per periods
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 200 Consignments of Components 50 Consignments of Raw Materials 10 Production runs per period
Product B 100 Consignments of Components 8 Consignments of Raw Materials 5 Production runs per period
Activity Based Costing ABC question
You are required toa) b) c) Calculate OH Cost of products A& B using CCA Identify appropriate cost drivers & calculate the Over Head Cost of A& B using ABC 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
A (1XRS 1.25) B (.6XRs 1.25)
Per Unit Total (Rs) Rs

1.25 1000x1.25=Rs1250 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

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

Comparison
Products Total (Rs) Diff ABC CCA Per Unit (Rs) 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
Receiving/Inspecting/Quality Assurance
Cost Driver
Purchase Requisition
Cost Of Activities
Rs 14,00,000
Production Scheduling/Machine Setups

Further Information
Numbers Of Batches
Rs 12,00,000
A No of Purchase Requisitions Number of Setups 1200 240
B 1800 260
C 2000 300
Calculate cost of ABC products under activity based costing Compare it with CCA
Activity Based Costing Answer-2
Activities Receiving Inspecting Quality Insurance Purchase Requisition
Activities Production Scheduling Machine Setups No. of Batches
Overhead=Rs14,00,000 P Requisitions=5000 Cost per Req= 1400000/5000 =Rs 280 /PR
Overhead = Rs12,00,000 Batches Setups = 800
Cost Per setups= 1200000/800 =1500 per setup
A a) Receiving/inspecting/ quality 280 x1200 10000 = Rs 33.60 b) Prod Scheduling/M Setups 1500x240 10000 = Rs 36.00
B 280 x1800 20000 Rs 25.20 1500x260 20000 Rs 19.50
C 280x2000 30000 =Rs 18.66 1500x300 30000 Rs 15.00
A(Rs)
B (Rs)
C(Rs)
Direct Materials Direct Labour Production Overhead a) Receiving/inspecting b) Scheduling/Setups

Total Cost PU
50.00 30.00
33.60 36.00 149.60
40.00 40.00
25.20 19.50 124.70
30.00 50.00
18.66 15.00 113.66
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
limitations
May require Substantial Resources

Benefits must outweigh the additional Cost May be difficult to apply in certain cases

Activity Based Costing

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