# Activity Based Costing

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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
Prod Departments

P3

S1

S1

Service Dept.

Activity Based Costing
Departmentalization

2 Process of allocating and apportioning POHEs to different departments or Factory cost centers (Prod & Service )

P1

P2
Prod Departments

P3

S1

S1

Service Dept.

Activity Based Costing

Departmentalization

P1

P2
Prod Departments

P3

S1

S1

Service Dept.

Activity Based Costing

Absorption
Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Operating Department (Machining) Operating Department (Assembly)

The Products

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 Rs Abhishek Banke Paraveen Devinder Total Average 110 200 150 140 600 150 Dessert Rs 0 80 40 40 160 40 Drinks Rs 40 140 80 60 320 80 Total Rs 150 420 270 240 1080 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

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

Activity Based Costing --Steps 1 Identify Activities

Set –UP Machining Receiving Packing Engineering

Activity Based Costing --Steps 2 Determine Cost for Each Activity

Set UpMachining ReceivingPacking Engineering-

Rs 10,000 Rs40,000 Rs10,000 Rs 10,000 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 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 2500 15000 24,500 3no 1900Hrs 3 no 3 500 7500 38000 7500 7500 15000 75,500

10,000 1 30,000 500Hrs 1,00,000

Hrs

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 CCA ABC Rs Rs Overhead 50 245 D Cost 20 20 Total 70 265 Cost Of Product B CCA ABC Rs Rs O’head 100 79.47 D Cost 40 40.00 Total 140 119.47

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
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 4 Consignments of Raw Materials 5 Production runs per period

Activity Based Costing ABC question

You are required toc) d) 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 (Rs)
1.25 0.75

Total

Rs 1000x1.25=Rs1250 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. Disbursing Kits =Rs1,25,000/10000=Rs 12.50 per Rec. = Rs1,25,000/5000=Rs 25 per issue

Activity Based Costing ABC Solution
Product A Requires 200 Consignments of Components 50 Consignments of Raw Materials 10 Production runs per period Product B 100 Consignments of Components 4 Consignments of Raw Materials 5 Production runs per period

B)

OVERHEAD Charging to Product Cost Overhead Allocation Total (Rs) 2,875 1,225 Per Unit 2.87 0.05

Products (Rs) A B

(200X10+50X12.50+10X25) (100X10+8X12.50+5X25 )

Activity Based Costing ABC Solution Comparison
Products A) B) Total (Rs) Diff ABC CCA 2,875 1,225 1250 1625 18750 17525 Per Unit (Rs) ABC CCA Diff 2.87 0.05 1.25 1.62 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
Receiving/Inspecting/Quality Assurance Production Scheduling/Machine Setups Further Information A No of Purchase Requisitions Number of Setups 1200 240 B 1800 260 C 2000 300

Cost Driver
Purchase Requisition Numbers Of Batches

Cost Of Activities
Rs 14,00,000 Rs 12,00,000

Calculate cost of ABC products under activity based costing Compare it with CCA

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) 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

B (Rs) 40.00 40.00 25.20 19.50 124.70

C(Rs) 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

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

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