Session 4-6:

Activity-Based-Costing [ABC] and Activity-Based-Management [ABM]

Practice Sums
Sums on Cost hierarchy:

Problem 1:
Hamilton, Inc., manufactures boom boxes (music systems with radio, cassette, and compact
disc players) for several well-known companies. The boom boxes differ significantly in their
complexity and their manufacturing batch sizes. The following costs were incurred in 2021:
a. Indirect manufacturing labour costs such as supervision that supports direct manufacturing
labour, $1,450,000.
b. Procurement costs of placing purchase orders, receiving materials, and paying suppliers
related to the number of purchase orders placed, $850,000.
c. Cost of indirect materials, $275,000.
d. Costs incurred to set up machines each time a different product needs to be manufactured,
$630,000.
e. Designing processes, drawing process charts, making engineering process changes for
products, $775,000.
f. Machine-related overhead costs such as depreciation, maintenance, production engineering,
$1,500,000 (These resources relate to the activity of running the machines.).
g. Plant management, plant rent, and plant insurance, $925,000.
1. Classify each of the preceding costs as output unit-level, batch-level, product-sustaining, or
facility-sustaining. Explain each answer.
2. Consider two types of boom boxes made by Hamilton, Inc. One boom box is complex to make
and is produced in many batches. The other boom box is simple to make and is produced in
few batches. Suppose that Hamilton needs the same number of machine-hours to make each
type of boom box and that Hamilton allocates all overhead costs using machine-hours as the
only allocation base. How, if at all, would the boom boxes be mis costed? Briefly explain why.
3. How is the cost hierarchy helpful to Hamilton in managing its business?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 1:
1. a. Indirect manufacturing labour costs of $1,450,000 support direct manufacturing labour
and are output unit-level costs. Direct manufacturing labour generally increases with output
units, and so will the indirect costs to support it.
b. Batch-level costs are costs of activities that are related to a group of units of a product rather
than each individual unit of a product. Purchase order-related costs (including costs of
receiving materials and paying suppliers) of $850,000 relate to a group of units of product and
are batch-level costs.
c. Cost of indirect materials of $275,000 generally changes with labour hours or machine hours
which are unit-level costs. Therefore, indirect material costs are output unit level costs.
d. Setup costs of $630,000 are batch-level costs because they relate to a group of units of
product produced after the machines are set up.
e. Costs of designing processes, drawing process charts, and making engineering changes for
individual products, $775,000, are product-sustaining because they relate to the costs of
activities undertaken to support individual products regardless of the number of units or batches
in which the product is produced.
f. Machine-related overhead costs (depreciation and maintenance) of $1,500,000 are output
unit-level costs because they change with the number of units produced.
g. Plant management, plant rent, and insurance costs of $925,000 are facility-sustaining costs
because the costs of these activities cannot be traced to individual products or services but
support the organization as a whole.

2. The complex boom box made in many batches will use significantly more batch-level
overhead resources compared to the simple boom box that is made in a few batches. In addition,
the complex boom box will use more product-sustaining overhead resources because it is
complex. Because each boom box requires the same amount of machine-hours, both the simple
and the complex boom box will be allocated the same amount of overhead costs per boom box
if Hamilton uses only machine-hours to allocate overhead costs to boom boxes. As a result, the
complex boom box will be under costed (it consumes a relatively high level of resources but is
reported to have a relatively low cost) and the simple boom box will be over costed (it
consumes a relatively low level of resources but is reported to have a relatively high cost).

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

3. Using the cost hierarchy to calculate activity-based costs can help Hamilton to identify both
the costs of individual activities and the cost of activities demanded by individual products.
Hamilton can use this information to manage its business in several ways:
a. Pricing and product mix decisions. Knowing the resources needed to manufacture and sell
different types of boom boxes can help Hamilton to price the different boom boxes and also
identify which boom boxes are more profitable. It can then emphasize its more profitable
products.
b. Hamilton can use information about the costs of different activities to improve
processes and reduce costs of the different activities. Hamilton could have a target of
reducing costs of activities (setups, order processing, etc.) by, say, 3% and constantly seek to
eliminate activities and costs (such as engineering changes) that its customers perceive as not
adding value.
c. Hamilton management can identify and evaluate new designs to improve performance
by analysing how product and process designs affect activities and costs.
d. Hamilton can use its ABC systems and cost hierarchy information to plan and manage
activities. What activities should be performed in the period and at what cost?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on Plant-wide, department, and ABC indirect cost rates:

Problem 2:
Sona BLW Precision (SBLWP) designs and produces automotive parts. In 2021, actual
variable manufacturing overhead is Rs.3,08,600. SBLWP’s simple costing system allocates
variable manufacturing overhead to its three customers based on machine-hours and prices its
contracts based on full costs. One of its customers has regularly complained of being charged
non-competitive prices, so SBLWP’s controller Mr. Dias realizes that it is time to examine the
consumption of overhead resources more closely. He knows that there are three main
departments that consume overhead resources: design, production, and engineering. Interviews
with the department personnel and examination of time records yield the following detailed
information:
Department Cost Driver Variable Usage of Cost Drivers by
Manufacturing Customer Contract
Overhead in Tata M&M Maruti
2021 Motors Motors Vehicle
Design CAD- Rs.39,000 110 200 80
design-hours
Production Engineering Rs.29,600 70 60 240
hours
Engineering Machine Rs.2,40,000 120 2,800 1,080
hours
Total Rs.3,08,600

You are required to:

1. Compute the variable manufacturing overhead allocated to each customer in 2021 using the
simple costing system that uses machine-hours as the allocation base.
2. Compute the variable manufacturing overhead allocated to each customer in 2021 using
department-based variable manufacturing overhead rates.
3. Comment on your answers in requirements 1 and 2. Which customer do you think was
complaining about being overcharged in the simple system? If the new department-based rates
are used to price contracts, which customer(s) will be unhappy? How would you respond to
these concerns?
4. How else might SBLWP use the information available from its department-by-department
analysis of variable manufacturing overhead costs?
5. SBLWP’s managers are wondering if they should further refine the department-by-
department costing system into an ABC system by identifying different activities within each

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

department. Under what conditions would it not be worthwhile to further refine the department
costing system into an ABC system?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 2:
1.
Actual plant-wide variable MOH rate based on machine hours, Rs.3,08,600  4,000 machine
hours = Rs. 77.15 per machine hour
Particulars Tata Motors M&M Maruti Total
Motors Vehicle
Variable manufacturing
overhead, allocated
based on machine hours
Tata Motors: Rs. (77.15 × 120 Rs.9,258 \
machine hours)
M&M Motors: Rs. (77.15 × Rs.2,16,020
2,800 machine hours)
Maruti Vehicle: Rs. (77.15 × Rs.83,322
1,080 machine hours)
Total Rs.3,08,600

2.
Department Variable Total Cost Cost Driver Rate p.u.
Manufacturing Driver Units
Overhead in
2021
Design Rs.39,000 390 Rs.100 per CAD-design-hour
Production Rs.29,600 370 Rs.80 per engineering hour
Engineering Rs.2,40,000 4,000 Rs.60 per machine hour

Particulars Tata Motors M&M Maruti Total

Motors Vehicle
Design-related overhead,
allocated on CAD-design
hours Rs.11,000
Tata Motors: (Rs.100 × 110
CAD-design-hours) Rs.20,000
M&M Motors: (Rs.100 × 200
CAD-design-hours) Rs.8,000
Maruti Vehicle: (Rs.100 × 80
CAD-design-hours) Rs.39,000
Production-related overhead,
allocated on engineering hours
Tata Motors: (Rs.80 × 70 Rs.5,600
engineering hours)
M&M Motors: (Rs.80 × 60 Rs.4,800
engineering hours)
Maruti Vehicle: (Rs.80 × 240 Rs.19,200
engineering hours)
Rs.29,600

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Engineering-related overhead,
allocated on machine hours
Tata Motors: (Rs.60 × 120 Rs.7,200
machine hours)
M&M Motors: (Rs.60 × 2,800 Rs.1,68,000
machine hours)
Maruti Vehicle: (Rs.60 × Rs.64,800
1,080 machine hours)
Rs.2,40,000
Total Rs.23,800 Rs.1,92,800 Rs.92,000 Rs.3,08,600

3.
Particulars Tata Motors M&M Motors Maruti Vehicle
a. Department rates Rs.23,800 Rs.1,92,800 Rs.92,000
(Requirement 2)
b. Plantwide rate Rs.9,258 Rs.2,16,020 Rs.83,322
(Requirement 1)
Ratio of (a) ÷ (b) 2.57 0.89 1.10

The variable manufacturing overhead allocated to Tata Motors increases by 157% under the
department rates, the overhead allocated to M&M Motors decreases by about 11% and the
overhead allocated to Maruti Vehicle increases by about 10%.
The three contracts differ sizably in the way they use the resources of the three departments.

The percentage of total driver units in each department used by the companies is:
Department Cost Driver Tata Motors M&M Motors Maruti Vehicle
Design CAD-design- 28% 51% 21%
hours
Production Engineering 19% 16% 65%
hours
Engineering Machine hours 3% 70% 27%

The Tata Motors contract uses only 3% of total machines hours in 2021, yet uses 28% of CAD
design-hours and 19% of engineering hours. The result is that the plantwide rate, based on
machine hours, will greatly underestimate the cost of resources used on the Tata Motors
contract. This explains the 157% increase in indirect costs assigned to the Tata Motors contract
when department rates are used. The Maruti Vehicle contract also uses far fewer machine hours
than engineering hours and is also under costed.
In contrast, the M&M Motors contract uses less of design (51%) and engineering (16%) than
of machine hours (70%). Hence, the use of department rates will report lower indirect costs for
M&M Motors than does a plantwide rate. M&M Motors was probably complaining under the

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

use of the simple system because its contract was being over costed relative to its consumption
of MOH resources. Tata Motors and Maruti Vehicle, on the other hand, were having their
contracts under costed and under-priced by the simple system. Assuming that SBLWP is an
efficient and competitive supplier, if the new department-based rates are used to price contracts,
Tata Motors and Maruti Vehicle will be unhappy. SBLWP should explain to Tata Motors and
Maruti Vehicle how the calculation was done, and point out Tata Motor’s high use of design
and engineering resources and Maruti Vehicle’s high use of engineering resources relative to
production machine hours. Discuss ways of reducing the consumption of those resources, if
possible, and show willingness to partner with them to do so. If the price rise is going to be
steep, perhaps offer to phase in the new prices.

4.
Other than for pricing, SBLWP can also use the information from the department-based system
to examine and streamline its own operations so that there is maximum value-added from all
indirect resources. It might set targets over time to reduce both the consumption of each indirect
resource and the unit costs of the resources. The department-based system gives SBLWP more
opportunities for targeted cost management.

5.
It would not be worthwhile to further refine the cost system into an ABC system if (1) a single
activity accounts for a sizable proportion of the department’s costs or (2) significant costs are
incurred on different activities within a department, but each activity has the same cost driver
or (3) there wasn’t much variation among contracts in the consumption of activities within a
department. If, for example, most activities within the design department were, in fact, driven
by CAD-design hours, then the more refined system would be costlier and no more accurate
than the department-based cost system. Even if there was sufficient variation, considering the
relative sizes of the 3 department cost pools, it may only be cost-effective to further analyse
the engineering cost pool, which consumes 78% (Rs.2,40,000  Rs.3,08,600) of the
manufacturing overhead.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on Activity-based costing, service company:

Problem 3:
Quikprint Corporation owns a small printing press that prints leaflets, brochures, and
advertising materials. Quikprint classifies its various printing jobs as standard jobs or special
jobs. Quikprint’s simple job-costing system has two direct-cost categories (direct materials and
direct labor) and a single indirect-cost pool. Quikprint operates at capacity and allocates all
indirect costs using printing machine-hours as the allocation base.
Quikprint is concerned about the accuracy of the costs assigned to standard and special jobs
and therefore is planning to implement an activity-based costing system. Quickprint’s ABC
system would have the same direct-cost categories as its simple costing system. However,
instead of a single indirect-cost pool there would now be six categories for assigning indirect
costs: design, purchasing, setup, printing machine operations, marketing, and administration.
To see how activity-based costing would affect the costs of standard and special jobs, Quikprint
collects the following information for the fiscal year 2021 that just ended.

You are required to:

1. Calculate the cost of a standard job and a special job under the simple costing system.
2. Calculate the cost of a standard job and a special job under the activity-based costing
system.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

3. Compare the costs of a standard job and a special job in requirements 1 and 2. Why do the
simple and activity-based costing systems differ in the cost of a standard job and a special job?
4. How might Quikprint use the new cost information from its activity-based costing system to
better manage its business?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 3:

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Relative to the ABC system, the simple costing system over costs standard jobs and under costs
special jobs. Both types of jobs need 10 machine hours per job, so in the simple system, they
are each allocated $671.70 in indirect costs. But, the ABC study reveals that each standard job
consumes less of the indirect resources such as setups, purchase orders, and design costs than
a special job, and this is reflected in the higher indirect costs allocated to special jobs in the
ABC system.

4.
Quikprint can use the information revealed by the ABC system to change its pricing based on
the ABC costs. Under the simple system, Quikprint was making a gross margin of 12% on each
standard job (($1,200 – $1,051.70)  $1,200) and 25% on each special job (($1,500 –
$1,121.70)  $1,500). But, the ABC system reveals that it is actually making a gross margin of
about 21% (($1,200 – $947)  $1,200) on each standard job and about 11% (($1,500 – $1,331)
 $1,500) on each special job. Depending on the market competitiveness, Quikprint may either
want to reprice the different types of jobs, or, it may choose to market standard jobs more
aggressively than before.
Quikprint can also use the ABC information to improve its own operations. It could examine
each of the indirect cost categories and analyse whether it would be possible to deliver the same
level of service, but consume fewer indirect resources, or find a way to reduce the per unit-
cost-driver cost of some of those indirect resources.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on ABC, wholesale, customer profitability:

Problem 4:
Zuari Wholesalers (ZW) operates at capacity and sells furniture items to four department-store
chains (customers). Mr. Zuari commented, “We apply ABC to determine product-line
profitability. The same ideas apply to customer profitability, and we should find out our
customer profitability as well.” ZW sends catalogues to corporate purchasing departments on
a monthly basis. The customers are entitled to return unsold merchandise within a six-month
period from the purchase date and receive a full purchase price refund. The following data were
collected from last year’s operations:
Particulars Chain 1 Chain 2 Chain 3 Chain 4
Gross sales Rs.55,000 Rs.25,000 Rs.1,00,000 Rs.75,000
Sales returns:
Number of items 101 25 65 35
Amount (value) Rs.11,000 Rs.3,500 Rs.7,000 Rs.6,500
Number of orders:
Regular 45 175 52 75
Rush 11 48 11 32

Mr. Zuari has calculated the following activity rates:

Activity Cost Driver Rate
Regular order processing Rs.25 per regular order
Rush order processing Rs.125 per rush order
Returned item processing Rs.15 per item
Catalogue and customer support Rs.1,100 per customer

Customers pay the transportation costs. The cost of goods sold averages 70% of sales.
You are required to determine the contribution to profit from each chain last year. Comment
on your solution.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 4:
Particulars Chain 1 Chain 2 Chain 3 Chain 4
Gross sales Rs.55,000 Rs.25,000 Rs.1,00,000 Rs.75,000
Less: Sales returns Rs.11,000 Rs.3,500 Rs.7,000 Rs.6,500
Net sales Rs.44,000 Rs.21,500 Rs.93,000 Rs.68,500
Less: Cost of goods sold (70%) Rs.30,800 Rs.15,050 Rs.65,100 Rs.47,950
Gross margin Rs.13,200 Rs.6,450 Rs.27,900 Rs.20,550
Customer-related costs:
Regular orders
Chain 1: Rs.25 × 45 orders Rs.1,125
Chain 2: Rs.25 × 175 orders Rs.4,375
Chain 3: Rs.25 × 52 orders Rs.1,300
Chain 4: Rs.25 × 75 orders Rs.1,875
Rush orders
Chain 1: Rs.125 × 11 orders Rs.1,375
Chain 2: Rs.125 × 48 orders Rs.6,000
Chain 3: Rs.125 × 11 orders Rs.1,375
Chain 4: Rs.125 × 32 orders Rs.4,000
Returned items
Chain 1: Rs.15 × 101 items Rs.1,515
Chain 2: Rs.15 × 25 items Rs.375
Chain 3: Rs.15 × 65 items Rs.975
Chain 4: Rs.15 × 35 items Rs.525
Catalogues and customer support Rs.1,100 Rs.1,100 Rs.1,100 Rs.1,100
Customer related costs Rs.5,115 Rs.11,850 Rs.4,750 Rs.7,500
Contribution (loss) margin Rs.8,085 (Rs.5,400) Rs.23,150 Rs.13,050
Contribution (loss) margin as 14.7% (21.6%) 23.15% 17.4%
percentage of gross sales

Comment:
The analysis indicates that customers’ profitability (loss) contribution varies widely from
(21.6%) to 23.15%. Immediate attention to Chain 2 is required which is currently showing a
loss contribution. The chain has a disproportionate number of both regular orders and rush
orders. Mr. Zuari should work with the management of Chain 2 to find ways to reduce the
number of orders, while maintaining or increasing the sales volume. If this is not possible, Mr.
Zuari should consider dropping Chain 2, if it can save the customer-related costs.
Chain 1 has a disproportionate number of the items returned as well as sale returns. The causes
of these should be investigated so that the profitability contribution of Chain 1 could be
improved.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on ABC:

Problem 5:
The job costing system at Smith’s Custom Framing has five indirect cost pools (purchasing,
material handling, machine maintenance, product inspection, and packaging). The company is
in the process of bidding on two jobs; Job 215, an order of 15 intricate personalized frames,
and Job 325, an order of 6 standard personalized frames. The controller wants you to compare
overhead allocated under the current simple job-costing system and a newly-designed activity-
based job-costing system. Total budgeted costs in each indirect cost pool and the budgeted
quantity of activity driver are as follows:

Information related to Job 215 and Job 325 follows. Job 215 incurs more batch-level costs
because it uses more types of materials that need to be purchased, moved, and inspected relative
to Job 325.

You are required to:

1. Compute the total overhead allocated to each job under a simple costing system, where
overhead is allocated based on machine-hours.
2. Compute the total overhead allocated to each job under an activity-based costing system
using the appropriate activity drivers.
3. Explain why Smith’s Custom Framing might favour the ABC job-costing system over the
simple job costing system, especially in its bidding process.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 5:
1.
Overhead allocation using a simple job-costing system, where overhead is allocated based
on machine hours:
Overhead allocation rate = $453,600  10,500 machine-hours = $43.20 per machine-hour
Overhead allocated to:
Job 215: ($43.20/MH × 40 hours) = $1,728
Job 325: ($43.20/MH × 60 hours) = $2,592

3.
The manufacturing manager likely would find the ABC job-costing system more useful in cost
management. Unlike direct manufacturing labor costs, the five indirect cost pools are
systematically linked to the activity areas at the plant. The result is more accurate product
costing. The manufacturing manager can seek to reduce both the level of activity (fewer
purchase orders, less material handling) and the cost of each activity (such as the cost per
inspection).

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Marketing managers can use ABC information to bid for jobs more competitively because ABC
provides managers with a more accurate reflection of the resources used for and the costs of
each job.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Job costing with single direct-cost category, single indirect-cost pool, law firm:

Problem 6.1:
Bhatia & Associates (B&A) is a recently formed law partnership. Mr. Bhatia, the managing
partner of B&A, has just finished a tense phone call with Mr. Agarwal, president of Vedanta
Coal. Mr. Agarwal strongly complained about the price B&A charged for some legal work
done for Vedanta Coal.
Mr. Bhatia also received a phone call from its only other client (Asahi Glass), which was very
pleased with both the quality of the work and the price charged on its most recent job. B&A
operates at capacity and uses a cost-based approach to pricing (billing) each job. Currently it
uses a simple costing system with a single direct-cost category (professional labour-hours) and
a single indirect-cost pool (general support). Indirect costs are allocated to cases on the basis
of professional labour-hours per case. The job files show the following:
Particulars Vedanta Coal Asahi Glass
Professional labour 104 hours 96 hours

Professional labour costs at B&A are Rs.700 an hour. Indirect costs are allocated to cases at
Rs.1,050 an hour. Total indirect costs in the most recent period were Rs.2,10,000.
Comment and compute:
1. Why is it important for B&A to understand the costs associated with individual jobs?
2. Compute the costs of the Vedanta Coal and Asahi Glass jobs using B&A’s simple costing
system.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 6.1:
1.
Pricing decisions at B&A are heavily influenced by reported cost numbers. Suppose B&A is
bidding against another firm for a client with a job similar to that of Vedanta Coal. If the costing
system overstates the costs of these jobs, B&A may bid too high and fail to land the client. If
the costing system understates the costs of these jobs, B&A may bid low, land the client, and
then lose money in handling the case.
2.
Particulars Vedanta Coal Asahi Glass Total
Direct professional labour
Vedanta Coal: (Rs.700 × 104 hours) Rs.72,800
Asahi Glass: (Rs.700 × 96 hours) Rs.67,200
Rs.1,40,000
Indirect costs allocated
Vedanta Coal: (Rs.1,050 × 104 hours) Rs.1,09,200
Asahi Glass: (Rs.1,050 × 96 hours) Rs.1,00,800
Rs.2,10,000
Total costs to be billed Rs.1,82,000 Rs.1,68,000 Rs.3,50,000

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Job costing with multiple direct-cost categories, single indirect-cost pool, law firm:
(continuation of Problem 6.1)

Problem 6.2:
Mr. Bhatia asks his assistant to collect details on those costs included in the Rs.2,10,000
indirect-cost pool that can be traced to each individual job. After analysis, B&A is able to
reclassify Rs.1,40,000 of the Rs.2,10,000 as direct costs:
Other Direct Costs Vedanta Coal Asahi Glass
Research support labour Rs.16,000 Rs.34,000
Computer time 5,000 13,000
Travel and allowances 6,000 44,000
Telephones/faxes 2,000 10,000
Photocopying 2,500 7,500
Total Rs.31,500 Rs.1,08,500

Mr. Bhatia decides to calculate the costs of each job as if B&A had used six direct cost-pools
and a single indirect-cost pool. The single indirect-cost pool would have Rs.70,000 of costs
and would be allocated to each case using the professional labour-hours base.

You are required to:

1. What is the revised indirect-cost allocation rate per professional labour-hour for B&A when
total indirect costs are Rs.70,000?
2. Compute the costs of the Vedanta Coal and Asahi Glass’s jobs if B&A had used its refined
costing system with multiple direct-cost categories and one indirect-cost pool.
3. Compare the costs of Vedanta Coal and Asahi Glass’s jobs in requirement 2 with those in
requirement 2 of Problem 6.1. Comment on the results.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 6.2:
1.
Indirect costs = Rs.70,000
Total professional labour-hours = 200 hours (104 hours on Vedanta Coal + 96 hours on Asahi
Glass)
Indirect cost allocated per professional labour-hour (revised) = Rs.70,000 ÷ 200 hours = Rs.350
per labour-hour

2.
Particulars Vedanta Asahi Glass Total
Coal
Direct costs:
Direct professional labour
Vedanta Coal: (Rs.700 × 104 hours) Rs.72,800
Asahi Glass: (Rs.700 × 96 hours) Rs.67,200
Rs.1,40,000
Other direct costs:
Research support labour Rs.16,000 Rs.34,000
Computer time 5,000 13,000
Travel and allowances 6,000 44,000
Telephones/faxes 2,000 10,000
Photocopying 2,500 7,500
Rs.1,40,000
Total direct costs Rs.1,04,300 Rs.1,75,700 Rs.2,80,000
Indirect costs allocated
Vedanta Coal: (Rs.350 × 104 hours) Rs.36,400
Asahi Glass: (Rs.350 × 96 hours) Rs.33,600
Rs.70,000
Total costs to be billed Rs.1,40,700 Rs.2,09,300 Rs.3,50,000

3.
Requirement (Total costs to be billed) Vedanta Asahi Glass Total
Coal
Problem 6.1 Rs.1,82,000 Rs.1,68,000 Rs.3,50,000
Problem 6.2 Rs.1,40,700 Rs.2,09,300 Rs.3,50,000
Over costed / (Under costed) Rs.41,300 (Rs.41,300) NIL

The Problem 6.2 approach directly traces Rs.1,40,000 of general support costs to the individual
jobs. In Problem 6.1, these costs are allocated on the basis of direct professional labour-hours.
The averaging assumption implicit in the Problem 6.1 approach appears incorrect – for
example, the Asahi Glass’s job has travel costs over seven times higher than the Vedanta Coal
case despite having lower direct professional labour-hours.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Job costing with multiple direct-cost categories, multiple indirect-cost pools, law firm:
(continuation of Problems 6.1 and 6.2).

Problem 6.3:
B&A has two classifications of professional staff: partners and associates. Mr. Bhatia asks his
assistant to examine the relative use of partners and associates on the recent Vedanta Coal and
Asahi Glass’s jobs. The Vedanta Coal job used 24 partner-hours and 80 associate-hours. The
Asahi Glass’s job used 56 partner-hours and 40 associate-hours. Therefore, totals of the two
jobs together were 80 partner-hours and 120 associate-hours. Mr. Bhatia decides to examine
how using separate direct-cost rates for partners and associates and using separate indirect-cost
pools for partners and associates would have affected the costs of the Vedanta Coal and Asahi
Glass’s jobs. Indirect costs in each indirect-cost pool would be allocated on the basis of total
hours of that category of professional labour. From the total indirect cost-pool of Rs.70,000,
Rs.46,000 is attributable to the activities of partners, and Rs.24,000 is attributable to the
activities of associates.
The rates per category of professional labour are as follows:
Category of professional Direct cost per hour Indirect cost per hour
labour
Partner Rs.1,000 Rs.46,000  80 hours =
Rs.575
Associate Rs.500 Rs.24,000  120 hours =
Rs.200

You are required to:

1. Compute the costs of the Vedanta Coal and Asahi Glass’s cases using B&A’s further refined
system, with multiple direct-cost categories and multiple indirect-cost pools.
2. For what decisions might B&A find it more useful to use this job-costing approach rather
than the approaches in Problems 6.1 or 6.2?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 6.3:
1.
Particulars Vedanta Asahi Glass Total
Coal
Direct costs:
Partner professional labour
Vedanta Coal: (Rs.1,000 × 24 hours) Rs.24,000
Asahi Glass: (Rs.1,000 × 56 hours) Rs.56,000
Rs.80,000
Associate professional labour
Vedanta Coal: (Rs.500 × 80 hours) Rs.40,000
Asahi Glass: (Rs.500 × 40 hours) Rs.20,000
Rs.60,000
Other direct costs:
Research support labour Rs.16,000 Rs.34,000
Computer time 5,000 13,000
Travel and allowances 6,000 44,000
Telephones/faxes 2,000 10,000
Photocopying 2,500 7,500
Rs.1,40,000
Total direct costs Rs.95,500 Rs.1,84,500 Rs.2,80,000
Indirect costs allocated
Indirect costs for partners
Vedanta Coal: (Rs.575 × 24 hours) Rs.13,800
Asahi Glass: (Rs.575 × 56 hours) Rs.32,200
Rs.46,000
Indirect costs for associates
Vedanta Coal: (Rs.200 × 80 hours) Rs.16,000
Asahi Glass: (Rs.200 × 40 hours) Rs.8,000
Rs.24,000
Total costs to be billed Rs.1,25,300 Rs.2,24,700 Rs.3,50,000

Comparison Vedanta Asahi Glass Total

Coal
Single direct cost/ Rs.1,82,000 Rs.1,68,000 Rs.3,50,000
Single indirect cost pool (Problem 6.1)
Multiple direct costs/ Rs.1,40,700 Rs.2,09,300 Rs.3,50,000
Single indirect cost pool (Problem 6.2)
Multiple direct costs/ Rs.1,25,300 Rs.2,24,700 Rs.3,50,000
Multiple indirect cost pools (Problem 6.3)

The higher the percentage of costs directly traced to each case, and the greater the number of
homogeneous indirect cost pools linked to the cost drivers of indirect costs, the more accurate
the product cost of each individual case.
The Vedanta Coal and Asahi Glass’s cases differ in how they use “resource areas” of B&A:

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Resource areas Vedanta Coal Asahi Glass
Partner professional labour 30% 70%
Associate professional 66.7 33.3
labour
Research support labour 32 68
Computer time 27.8 72.2
Travel and allowances 12 88
Telephones/faxes 16.7 83.3
Photocopying 25 75

The Vedanta Coal case makes relatively low use of the higher-cost partners but relatively
higher use of the lower-cost associates than does Asahi Glass. As a result, it also uses less of
the higher indirect costs required to support partners compared to associates. The Vedanta Coal
case also makes relatively lower use of the support labour, computer time, travel, phones/faxes,
and photocopying resource areas than does the Asahi Glass case.

2.
The specific areas where the multiple direct/multiple indirect (MD/MI) approach can provide
better information for decisions at B&A include:
Pricing and product (case) emphasis decisions. In a bidding situation using single
direct/single indirect (SD/SI) or multiple direct/single indirect (MD/SI) data, B&A may win
bids for legal cases on which it will subsequently lose money. It may also not win bids on
which it would make money with a lower-priced bid.
From a strategic viewpoint, SD/SI or MD/SI exposes B&A to cherry-picking by competitors.
Other law firms may focus exclusively on Vedanta Coal-type cases and take sizable amounts
of - profitable‖ business from B&A. MD/MI reduces the likelihood of B&A losing cases on
which it would have made money.
Client relationships. MD/MI provides a better “road map” for clients to understand how costs
are accumulated at B&A. B&A can use this road map when meeting with clients to plan the
work to be done on a case before it commences. Clients can negotiate ways to get a lower-cost
case from B&A, given the information in MD/MI - for example, (a) use a higher proportion of
associate labour time and a lower proportion of a partner time, and (b) use fax machines more
and air travel less. If clients are informed in advance how costs will be accumulated, there is
less likelihood of disputes about bills submitted to them after the work is done.
Cost control. The MD/MI approach better highlights the individual cost areas at B&A than
does the SD/SI or MD/SI approaches:

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Particulars MD/MI SD/SI MD/SI
Number of direct 7 1 7
cost categories
Number of indirect 2 1 1
cost categories
Total 9 2 8

MD/MI is likely to promote better cost-control practices than SD/SI or MD/SI, as the nine cost
categories in MD/MI give B&A a better handle on how to effectively manage different
categories of both direct and indirect costs.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on Plant-wide, department, and activity-cost rates:

Problem 7:
Hanung Toys makes two models of toy airplanes, fighter jets, and cargo planes. The fighter
jets are more detailed and require smaller batch sizes. The controller has asked you to compare
plant-wide, department, and activity-based cost allocations.
Hanung Toys
Budgeted information p.u.
For the year ended 31st December 2021
Particulars Fighters Cargo Total
Assembly department
Direct materials Rs.2.50 Rs.3.75 Rs.6.25
Direct manufacturing labour 3.50 2.00 5.50
Total direct cost p.u. Rs.6.00 Rs.5.75 Rs.11.75
Painting department
Direct materials Rs.0.50 Rs.1.00 Rs.1.50
Direct manufacturing labour 2.25 1.50 3.75
Total direct cost p.u. Rs.2.75 Rs.2.50 Rs.5.25
Number of units produced 800 740

The budgeted overhead cost for each department is as follows:

Particulars Assembly Painting Total
department department
Materials handling Rs.1,700 Rs.900 Rs.2,600
Quality inspection 2,750 1,150 3,900
Utilities 2,580 2,100 4,680
Total Rs.7,030 Rs.4,150 Rs.11,180

Other information are as follows:

Materials handling and quality inspection costs vary with the number of batches processed in
each department. The budgeted number of batches for each product line in each department is
as follows:
Particulars Fighters Cargo Total
Assembly department 150 48 198
Painting department 100 32 132
Total 250 80 330

Utilities costs vary with direct manufacturing labour cost in each department.
You are required to:
1. Calculate the budgeted cost per unit for fighter jets and cargo planes based on a single
plant-wide overhead rate, if total overhead is allocated based on total direct costs.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

2. Calculate the budgeted cost per unit for fighter jets and cargo planes based on departmental
overhead rates, where assembly department overhead costs are allocated based on direct
manufacturing labour costs of the assembly department and painting department overhead
costs are allocated based on total direct costs of the painting department.
3. Calculate the budgeted cost per unit for fighter jets and cargo planes if Hanung Toys
allocates overhead costs using activity-based costing.
4. Explain how activity-based costing could improve or reduce decision quality.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 7:
1. Plant-wide costing rate
Particulars Fighters Cargo Total
Direct materials
Assembly department Rs.2.50 Rs.3.75 Rs.6.25
Painting department 0.50 1.00 1.50
Total Rs.3.00 Rs.4.75 Rs.7.75
Direct labour
Assembly department Rs.3.50 Rs.2.00 Rs.5.50
Painting department 2.25 1.50 3.75
Total Rs.5.75 Rs.3.50 Rs.9.25
Direct materials
Fighters: (Rs.3.00 × 800 units) Rs.2,400
Cargo: (Rs.4.75 × 740 units) Rs.3,515
Rs.5,915
Direct manufacturing labour
Fighters: (Rs.5.75 × 800 units) Rs.4,600
Cargo: (Rs.3.50 × 740 units) Rs.2,590
Rs.7,190
Total direct costs Rs.7,000 Rs.6,105 Rs.13,105
Plant-wide overhead rate
(Rs.11,180  Rs.13,105) = Rs.0.8531 per direct cost rupees
Total direct costs Rs.7,000 Rs.6,105
Overhead allocated
Fighters: (0.8531 × Rs.7,000) 5,971.77
Cargo: (0.8531 × Rs.6,105) 5,208.23
Total costs Rs.12,971.77 Rs.11,313.23
Number of units produced 800 740
Total costs p.u. Rs.16.21 Rs.15.29
(Total costs  Number of units produced)

2. Departmental costing

Budgeted overhead rate Budgeted assembly department overhead costs

Assembly department =
Budgeted assembly department direct manufacturing labour costs

Rs.7,030
=
(Rs.3.50 × 800 units + Rs.2.00 × 740 units)
Rs.7,030
=

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 (Rs.2,800 + Rs.1,480)
Rs.7,030
=
Rs.4,280

= Rs.1.6425 per direct manufacturing labour rupees

Budgeted overhead rate Budgeted painting department overhead costs

Painting department =
Budgeted painting department direct manufacturing labour costs

Rs.4,150
=
(Rs.2.75 × 800 units + Rs.2.50 × 740 units)
Rs.4,150
=
(Rs.2,200 + Rs.1,850)
Rs.4,150
=
Rs.4,050

= Rs.1.0247 per direct costs rupees

Particulars Fighters Cargo Total

Direct materials Rs.2,400 Rs.3,515 Rs.5,915
Direct manufacturing labour 4,600 2,590 7,190
Total direct costs Rs.7,000 Rs.6,105 Rs.13,105
Allocated overhead
Assembly department:
Fighters: (1.6425 × Rs.2,800*) Rs.4,599
Cargo: (1.6425 × Rs.1,480) Rs.2,431
Rs.7,030
Painting department:
Fighters: (1.0247 × Rs.2,200**) 2,254
Cargo: (1.0247 × Rs.1,850) 1,896
Rs.4,150
Total costs Rs.13,853 Rs.10,432 Rs.24,285
Number of units produced 800 740

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Total costs p.u. Rs.17.32 Rs.14.10
(Total costs  Number of units produced)
* Direct manufacturing labour costs in Assembly department calculated previously:
Fighters, Rs.3.50 × 800 units = Rs.2,800; Cargo, Rs.2 × 740 units = Rs.1,480
** Direct costs of Painting department calculated previously:
Fighters, Rs.2.75 × 800 units = Rs.2,200; Cargo, Rs.2.50 × 740 units = Rs.1,850

3. Activity-based Costing
Assembly department:
Rs.1,700
Budgeted materials handling rate =
198 batches

= Rs.8.5859 per batch

Rs.2,750
Budgeted quality inspection rate =
198 batches

= Rs.13.8889 per batch

Rs.2,580
Budgeted utilities rate =
Rs.4,280

= Rs.0.6028 per direct manufacturing labour rupees

Painting department:
Rs.900
Budgeted materials handling rate =
132 batches

= Rs.6.8182 per batch

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Rs.1,150
Budgeted quality inspection rate =
132 batches

= Rs.8.7121 per batch

Rs.2,100
Budgeted utilities rate =
(Rs.2.25 × 800 units + Rs.1.50 × 740 units)
Rs.2,100
=
(Rs.1,800 + Rs.1,110)
Rs.2,100
=
Rs.2,910

= Rs.0.7217 per direct manufacturing labour rupees

Particulars Fighters Cargo Total

Direct materials Rs.2,400 Rs.3,515 Rs.5,915
Direct manufacturing labour 4,600 2,590 7,190
Total direct costs Rs.7,000 Rs.6,105 Rs.13,105
Allocated assembly department overhead
Materials handling
Fighters: (Rs.8.5859 × 150 batches) Rs.1,288
Cargo: (Rs.8.5859 × 48 batches) Rs.412
Rs.1,700
Inspection
Fighters: (Rs.13.8889 × 150 batches) 2,083
Cargo: (Rs.13.8889 × 48 batches) 667
Rs.2,750
Utilities
Fighters: (0.6028 × Rs.2,800) 1,688
Cargo: (0.6028 × Rs.1,480) 892
Rs.2,580
Allocated painting department overhead

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

 Materials handling
Fighters: (Rs.6.8182 × 100 batches) Rs.682
Cargo: (Rs.6.8182 × 32 batches) Rs.218
Rs.900
Inspection
Fighters: (Rs.8.7121 × 100 batches) 871
Cargo: (Rs.8.7121 × 32 batches) 279
Rs.1,150
Utilities
Fighters: (0.7217 × Rs.1,800*) 1,299
Cargo: (0.7217 × Rs.1,110) 801
Rs.2,100
Total costs Rs.14,911 Rs.9,374 Rs.24,285
Number of units produced 800 740
Total costs p.u. Rs.18.64 Rs.12.67
(Total costs  Number of units produced)
* Direct manufacturing labour costs in Painting department calculated previously:
Fighters, Rs.2.25 × 800 units = Rs.1,800; Cargo, Rs.1.50 × 740 units = Rs.1,110

4. Activity-based cost information can improve decisions by allowing managers to understand

how different aspects of cost influence total cost per unit. Using ABC and determining the
drivers of overhead costs help Hanung Toys understand that cargo planes were over costed and
fighter jets were under costed.
Managers can also understand the drivers of different cost categories and use this information
for pricing and product-mix decisions, cost reduction and process-improvement decisions,
design decisions, and to plan and manage activities. However, too much detail can overload
managers who don’t understand the data or what it means. Also, managers looking at per-unit
data may be misled when considering costs that aren’t unit-level costs.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on Choosing cost drivers, activity-based costing, activity-based management:

Problem 8:
Pumpkin Bags (PB) is a designer of high-quality backpacks and purses. Each design is made
in small batches. Each spring, PB comes out with new designs for the backpack and for the
purse. The company uses these designs for a year, and then moves on to the next trend. The
bags are all made on the same fabrication equipment that is expected to operate at capacity.
The equipment must be switched over to a new design and set up to prepare for the production
of each new batch of products. When completed, each batch of products is immediately shipped
to a wholesaler. Shipping costs vary with the number of shipments. Budgeted information for
the year is as follows:

Other budget information follows:

You are required to:

1. Identify the cost hierarchy level for each cost category.
2. Identify the most appropriate cost driver for each cost category. Explain briefly your choice
of cost driver.
3. Calculate the budgeted cost per unit of cost driver for each cost category.
4. Calculate the budgeted total costs and cost per unit for each product line.
5. Explain how you could use the information in requirement 4 to reduce costs.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 8:
1.
Direct materials—purses Output unit-level costs
Direct materials—backpacks Output unit-level costs
Direct manufacturing labor—purses Output unit-level costs
Direct manufacturing labor—backpacks Output unit-level costs
Setup Batch-level costs
Shipping Batch-level costs
Design Product-sustaining costs
Plant utilities and administration Facility-sustaining costs

2.
Direct materials—purses Number of purses

Direct materials—backpacks Number of backpacks

Direct manufacturing labour—purses Number of purses

Direct manufacturing labour—backpacks Number of backpacks

Setup Number of batches

Shipping Number of batches
Design Number of designs
Plant utilities and administration Hours of production
Direct material and direct manufacturing labour are costs that can be easily traced to output,
which in this case is the number of purses or backpacks produced.
Setup and shipping are both a function of the number of batches produced.
Design is related to the number of designs created for each product.
Plant utilities and administration result from general activity level in the plant. Thus, hours of
production seem to be an appropriate cost driver.

3.
Direct materials—purses $379,290 ÷ 3,350 purses = $113.22 per purse
Direct materials—backpacks $412,920 ÷ 6,050 backpacks = $68.25 per backpack
Direct manufacturing labour—purses $98,000 ÷ 3,350 purses = $29.25 per purse
Direct manufacturing labour—backpacks $120,000 ÷ 6,050 backpacks = $19.83 per backpack

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Setup $65,930  190 batches = $347 per batch
Shipping $73,910  190 batches = $389 per batch
Design $166,000 ÷ 4 designs = $41,500 per design
Plant utilities and administration $243,000 ÷ 4,050 hours = $60 per hour

5.
Based on this analysis, over 50% of product cost relates to direct material. Managers should
determine whether the material costs can be reduced. Producing in small lots increases the
setup
and shipping costs. While both are relatively small components of product cost, management
may want to evaluate ways to reduce the number of setups and the cost per setup. Of the indirect
costs, the product- and facility-sustaining costs are the highest. Management should review the
design process for cost savings and examine why it takes so long to produce purses relative to
backpacks.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on ABC, health care:

Problem 9:
Apollo Health Centre (AHC) runs two programs: drug addict rehabilitation and aftercare
(counselling and support of patients after release from a mental hospital). The centre’s budget
for 2021 follows:
Particulars Amount (Rs.) Amount (Rs.)
Professional salaries:
4 physicians (Rs.15,00,000 × 4) 60,00,000
12 psychologists (Rs.7,50,000 × 12) 90,00,000
16 nurses (Rs.3,00,000 × 16) 48,00,000
1,98,00,000
Medical supplies 22,00,000
Rent and clinic maintenance 12,60,000
Administrative costs to manage patient charts, 44,00,000
food, laundry, etc.
Laboratory services 8,40,000
Total 2,85,00,000

Dr. Reddy, the director of the centre, is keen on determining the cost of each program. He
compiled the following data describing employee allocations to individual programs:
Particulars Drug Aftercare Total employees
Physicians 4 - 4
Psychologists 4 8 12
Nurses 6 10 16

Dr. Reddy has recently become aware of activity-based costing as a method to refine costing
systems. He asks his accountant, Mr. Singh, how he should apply this technique. Mr. Singh
obtains the following budgeted information for 2021:
Particulars Drug Aftercare Total employees
Square feet of space occupied by 9,000 12,000 21,000
each program
Patient-years of service 50 60 110
Number of laboratory tests 1,400 700 2,100

You are required to:

1. a. Selecting cost-allocation bases that you believe are the most appropriate for allocating
indirect costs to programs, calculate the budgeted indirect cost rates for medical supplies; rent
and clinic maintenance; administrative costs for patient charts, food, and laundry; and
laboratory services.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

b. Using an activity-based costing approach to cost analysis, calculate the budgeted cost of
each program and the budgeted cost per patient-year of the drug program.
c. What benefits can AHC obtain by implementing the ABC system?
2. What factors, other than cost, do you think AHC should consider in allocating resources to
its programs?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 9:
1a.
Medical supplies costs
Medical supplies rate =
Total number of patient-years
Rs.22,00,000
=
110 patient-years

= Rs.20,000 per patient-year

Rent and clinic maintenance costs
Rent and clinic =
maintenance rate Total amount of square feet of space
Rs.12,60,000
=
21,000 square feet

= Rs.60 per square feet

Administrative costs to maintain patient charts, etc.
Administrative =
costs rate Total number of patient-years
Rs.44,00,000
=
110 patient-years

= Rs.40,000 per patient-year

Laboratory services costs
Laboratory services rate =
Total number of laboratory tests
Rs.8,40,000
=
2,100 tests

= Rs.400 per test

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

These cost drivers are chosen as the ones that best match the descriptions of why the costs arise.
Other answers are acceptable, provided that clear explanations are given.

1b.
Activity-based costs for each program and cost per patient-year of the drug program follow:
Particulars Drug Aftercare Total
Direct labour costs
Physicians
Drug: (Rs.15,00,000 × 4) Rs.60,00,000
Aftercare: (Rs.15,00,000 × 0) Rs.0
Rs.60,00,000
Psychologists
Drug: (Rs.7,50,000 × 4) 30,00,000
Aftercare: (Rs.7,50,000 × 8) 60,00,000
Rs.90,00,000
Nurses
Drug: (Rs.3,00,000 × 6) 18,00,000
Aftercare: (Rs.3,00,000 × 10) 30,00,000
Rs.48,00,000
Total Rs.1,08,00,000 Rs.90,00,000 Rs.1,98,00,000
Medical supplies*
Drug: (Rs.20,000 × 50 patient-years) Rs.10,00,000
Aftercare: (Rs.20,000 × 60) Rs.12,00,000
Rs.22,00,000
Rent and clinic maintenance**
Drug: (Rs.60 × 9,000 square feet) 5,40,000
Aftercare: (Rs.60 × 12,000) 7,20,000
Rs.12,60,000
Administrative costs***
Drug: (Rs.40,000 × 50 patient-years) 20,00,000
Aftercare: (Rs.40,000 × 60) 24,00,000
Rs.44,00,000
Laboratory services****
Drug: (Rs.400 × 1,400 tests) 5,60,000
Aftercare: (Rs.400 × 700) 2,80,000
Rs.8,40,000
Total costs Rs.1,49,00,000 Rs.1,36,00,000 Rs.2,85,00,000
Costs per patient-year
(Rs.1,49,00,000  50 patient-years) Rs.2,98,000
* Allocated using patient-years
** Allocated using square feet of space
*** Allocated using patient-years
**** Allocated using number of laboratory tests

1c.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

The ABC system more accurately allocates costs because it identifies better cost drivers. The
ABC system chooses cost drivers for overhead costs that have a cause-and-effect relationship
between the cost drivers and the costs. Of course, AHC should continue to evaluate if better
cost drivers can be found than the ones they have identified so far.
By implementing the ABC system, AHC can gain a more detailed understanding of costs and
cost drivers. This is valuable information from a cost management perspective. The system can
yield insight into the efficiencies with which various activities are performed. AHC can then
examine if redundant activities can be eliminated. AHC can study trends and work toward
improving the efficiency of the activities.
In addition, the ABC system will help AHC determine which programs are the costliest to
operate. This will be useful in making long-run decisions as to which programs to offer or
emphasize. The ABC system will also assist AHC in setting prices for the programs that more
accurately reflect the costs of each program.

2. The concern with using costs per patient-year as the rule to allocate resources among its
programs is that it emphasizes “input” to the exclusion of “outputs” or effectiveness of the
programs. After-all, AHC’s goal is to cure patients while controlling costs, not minimize costs
per-patient year. The problem, of course, is measuring outputs.
Unlike many manufacturing companies, where the outputs are obvious because they are
tangible and measurable, the outputs of service organizations are more difficult to measure.
Examples are “cured” patients as distinguished from “processed” or “discharged” patients,
“educated” as distinguished from “partially educated” students, and so on.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Sums on Unused capacity, activity-based costing, activity-based management:

Problem 10:
Joy’s Netballs is a manufacturer of high-quality footballs and volleyballs. Setup costs are
driven by the number of batches. Equipment and maintenance costs increase with the number
of machine-hours, and lease rent is paid per square foot. Capacity of the facility is 12,000
square feet and Joy is using only 70% of this capacity. Joy records the cost of unused capacity
as a separate line item, and not as a product cost. The following is the budgeted information
for Joy:
Joy’s Netballs
Budgeted Costs and Activities
For the Year Ended March 31, 2022
Particulars Amount (Rs.)
Direct materials – footballs 2,09,750
Direct materials – volleyballs 3,58,290
Direct manufacturing labour – footballs 1,07,333
Direct manufacturing labour – volleyballs 1,02,969
Setup 1,43,500
Equipment and maintenance costs 1,09,900
Lease rent, insurance, utilities, etc. 2,16,000
Total 12,47,742

Other budget information follows:

Particulars Footballs Volleyballs
Number of balls 66,000 1,00,000
Machine hours 11,000 12,500
Number of batches 300 400
Square footage of production space used 3,360 5,040

You are required to:

1. Calculate the budgeted cost per unit of cost driver for each indirect cost pool.
2. What is the budgeted cost of unused capacity?
3. What is the budgeted total cost and the cost per unit of resources used to produce (a)
footballs and (b) volleyballs?
4. What factors should Joy consider if it has the opportunity to manufacture a new line of
basketballs?

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Solution to Problem 10:
1.
Particulars Footballs Volleyballs Total
Number of batches 300 400 700
Machine hours 11,000 12,500 23,500
Setup cost per batch = Rs.1,43,500 ÷ 700 batches = Rs.205 per batch.
Equipment and maintenance cost per machine hour = Rs.1,09,900 ÷ 23,500 machine hours
= Rs.4.6766 per machine hour.
Lease rent, insurance, utilities, etc. per square feet = Rs.2,16,000 ÷ 12,000 sq. ft. of capacity
= Rs.18 per sq. ft.

2.

Unused capacity = Total capacity – Capacity used for footballs production – Capacity used for
volleyballs production
= (12,000 – 3,360 – 5,040) sq. ft. = 3,600 sq. ft.
Cost of unused capacity = Rs.18 per sq. ft × 3,600 sq. ft. = Rs.64,800

3.
Particulars Footballs Volleyballs Total
Direct materials Rs.2,09,750 Rs.3,58,290 Rs.5,68,040
Direct manufacturing labour 1,07,333 1,02,969 2,10,302
Setup
Footballs: (Rs.205 × 300 batches) Rs.61,500
Volleyballs: (Rs.205 × 400 batches) Rs.82,000
Rs.1,43,500
Equipment and maintenance
Footballs: (Rs.4.6766 × 11,000 51,443
machine hours)
Volleyballs: (Rs.205 × 12,500 machine 58,457
hours)
Rs.1,09,900
Lease rent, etc.
Footballs: (Rs.18 × 3,360 sq. ft.) 60,480
Volleyballs: (Rs.18 × 5,040 sq. ft.) 90,720
Rs.1, 51,200
Budgeted total costs Rs.4,90,506 Rs.6,92,436 Rs.11,82,942
Number of balls 66,000 1,00,000
(Budgeted total costs) Rs.4,90,506 Rs.6,92,436
 Number of balls  66,000  1,00,000
Budgeted costs per ball Rs.7.43 Rs.6.92

4.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)

Currently, Joy only utilizes 70% of its available capacity. Managers should consider whether
the excess capacity is sufficient to produce basketballs. Other issues to consider include
demand for the proposed product, the competition, capital investment needed to start and
support this product line, and the availability of skilled and unskilled labour needed to
manufacture basketballs.

PREPARED BY: PROF. RANJAN DASGUPTA (IIM RAIPUR)