Presented bySneha Bajpai MBA-2nd sem Roll no.

-39 FMS-BHU

Two-Dimensional ABC and ActivityBased Management

Cost Assignment View

Resource cost Process View

Activity Evaluation activities Performance measures

Activity Analysis Root cause Activity triggers

Cost objects

Traditional product costing systems were designed when the company manufactured narrow range of products. Also it can only measure volume related cost. Non-volume related activities like material handling , setup etc are important and their costs cannot be apportioned on volume basis. However today companies produce a wide range of products. Simple methods of apportioning overheads based on direct labour are not justified. Hence the need for activity based costing arises.

All of a companys activities are considered as product costs. Philosophy of ABC is that costs can be controlled more effectively by focusing directly on managing the forces that cause the activities-the cost drivers rather than costs. Thus ABC provides better and more accurate information and decision making on prices and product mix and for the control of manufacturing operations. Costs are grouped into pools according to the activities which drive them. E.g.-a cost pool may be of procurement of goods. In this, all the costs associated with the procurement(ordering,inspection,sorting)would be included in this cost pool and cost driver identified. The procurement cost per requisition is then calculated and this provides a means of tracing the cost of procurement to product.

The following are the three key areas of ABC: Product cost differentiation activities and their cost drivers identification of non-value added cost ABC is the planned and systematic study and determination of cost of each of the branches of business activities that add to the value of product and services. This matrix shows long and short term cost strategy presented as follows: Short term Long term
Product value pricing Value addition Corporate growth

The steps required to develop an ABC system are as follows Identify the main activities performed in the organization, such as manufacturing, assembly etc., as well as support activities ,including purchasing ,packing and dispatching. Identify the factors which influence the cost of each activity-the cost drivers. Collecting accurate data on direct labour , material and overhead costs. Establishing the demands made by particular products on activities, using the cost drivers as a measure of demand. Trace the cost of activities to products according to a products demand for each activity.

Focus on expensive resources, thus directing attention to resource categories where the new costing process has the potential to make big differences on product cost. Emphasis on resources whose consumption varies significantly by product and product type-look for diversity. Focus on resources whose demand patterns are uncorrelated with traditional allocation measures. ABC is the process of tracing costs first from resources to activities and then from activities to specific products. The technique of ABC lays the importance of different costs for different purposes and the identification of just those costs, which are relevant to a particular decision. It refines the ideas and concepts of conventional methods.

Functional areas Material management

Activities involved 1.Issuing tenders 2.Receiving indents 3.Inspection of material

1.Receive sample 2.Test sample 3.Issue of test certificates 1.Recruitment 2.Training 3.Labour turnover 1.Demand criterion 2.Advertising effort 3.Preparation of sales forecast

Cost drivers No. of tenders issued No. of indents No. of purchase orders
No. of batches produced

Quality management

Personal management

No. of employee recruited Percentage increase in sales Time spent with distributors

marketing

ILLUSTRATION:

A COMP. PRODUCES 4 PRODUCTS A ,B ,C, D USING THE SAME PLANT AND PROCESS. FOLLOWING ARE THE INFO RELATED TO PRODUCTION PERIOD:
product volume MATERIAL COST/UNIT 5 15 16 DIRECT MACHINE LABOUR/UN TIME/UNIT IT HOUR 2 1 LABOUR COST/UNIT RS. 3 3 12

A B C

500 5000 600

7000

1 1/2

1 1/2

TOTAL PRODUCTION OVERHEADS: Factory overhead applicable to machine oriented activity Set up cost Cost of ordering material Handling material Administration for spare parts

: Rs. 37,425 : Rs. 4,355 : Rs. 1,920 : Rs. 7,580 : Rs. 8,600 Rs. 59,880

PERIOD

No. of set ups 1 6 2 8 ---17

No. of material ordered 1 4 1 4 ---10

No. of time material handled 2 10 3 12 ----27

No. of spare parts 2 5 1 4 ---12

A B C D

COMPUTE AN OVERHEAD COST PER PRODUCT USING ABC, TRACING

OVERHEADS TO PRODUCTION UNITS BY MEANS OF COST DRIVERS.

SOLUTION:

Overhead cost based on machine hr rate:

product A B C D volume 500 5000 600 7000 machine time/unit 1 1 1/2 Total machine time 125 1250 600 10500 -------12475

TOTAL OVERHEAD COST ABSORBED BY THE PRODUCTS= TOTAL PRODUCTION OVERHEAD/ total machine time Rs. 59880/12475 = Rs. 4.80 per hour = Rs 1.20 =Rs 1.20 =Rs. 4.80 = Rs. 7.20

Thus overhead cost per product

A= 1/4 of Rs 4.80 B= 1/4 of Rs 4.80 C= 1 of Rs. 4.80 D=1.5 of Rs. 4.80

Activity based costing..

Factory overhead applicable to machine oriented activity= Rs 37,424 Total machine hours=12,475

Machine hour rate for machine overhead charges= 37,424/12,475 = Rs. 3 per hour
Set up cost to be applied on the basis of no of set ups=Rs 4355/17 =Rs 256.18 per set-ups (Cost driver is no. of set-ups) Materials ordering cost to be absorbed on the basis of number of material orders= ordering cost/ total no of orders = Rs 1920/10 = Rs 192 per order (Cost driver is number of times material is ordered.)

Contd. Material handling cost = handling cost / No. of times material handled. = Rs 7580/27 = Rs 280.74 per time material handled (Cost driver is number of times material handled) Administration for spare parts = Rs 8,600/ 12 =Rs 716.67

Computation of overhead cost per product using ABC 0verhead items Machine overhead A B hour @ Rs 3/mc hr= Rs. hour @ Rs 3/mc hr= Rs. 0.75 0.75 (1 X Rs 256.18)/500 volume =1.12 (1 X Rs 280.74)/500 =0.38 (1 X Rs 192)/500 =0.38 6X Rs 256.18)/5000 volume =0.56 (10X Rs 280.74)/5000 =0.15 (4xRs.192)/5000 =0.72

Set up cost

Material handling cost

Material ordering cost

Administration for spare parts

Total overhead cost/unit a/c to ABC

(1 X Rs 716.67)/500 =0.38
5.63

(5X Rs 716.67)/5000 =0.717

2.49

Over head cost based on two system and their difference products Overhead cost per unit based on ABC Overhead cost difference based on present sys of machine hr rate of Rs.4.80 /hr 1.20 1.20 4.80 7.20 +4.43 +1.29 +1.96 -1.41

A B C D

5.63 2.49 6.67 5.79

Benefits of implementing ABC: Cost management and downsizing. Determination of product and services cost.

Improvement in performance.
Product/service pricing. Make or buy decisions. Transfer pricing.

Substantial resources required to implement and maintain.

Resistance to unfamiliar numbers and reports.

Desire to fully allocate all costs to products

Potential misinterpretation of unfamiliar numbers

Does not conform to GAAP. Two costing systems may be needed

Conclusion:ABC may not be appropriate for all companies, particularly those where overheads are small and which do not produce a wide range of products. But many of the benefits of ABC can still be obtained by implementing a partial system, which focuses on most important activities. Nor the method should be used for preparing monthly profit statements. Traditional methods should be used for that, leaving ABC to support strategic decision-making, profitability analysis and control of manufacturing cost.

THANK YOU..