ACTIVITY BASE COSTING

DIWAKAR EDUCATION HUB

 What is Budgetary Control?

• Definition: Budgetary control refers to how

well managers utilize budgets to monitor and
control costs and operations in a given
accounting period. In other words, budgetary
control is a process for managers to set
financial and performance goals with budgets,
compare the actual results, and adjust
performance, as it is needed.
• What Does Budgetary Control Mean?
• You can think of a budget like a report card in
school. It shows how well you performed in
that subject during the school year. The
budget process does the same thing.
Management can set goals and evaluate the
progress.
There are typically four steps in any budgetary
control process that managers follow.
• First, a budget needs to be created. To put it
simply, a company performance budget is really
just a set of financial goals that management wants
to achieve. These could be sales or spending goals.
• Second, after the budget is created, management
needs to compare, analyze, and interpret the
actual performance results with the budgeted
goals. Management typically uses a budget report
 for this comparison
• Third, after the comparison has been made,
managers need to improve the under performing
operations and continue to strengthen the
favorable ones. The budget report easily allow
managers to focus on unfavorable operations
because all areas that meet the budget are
marked with an F for favorable variance while
the poorly performing areas are marked with a U
for unfavorable variance.
• The fourth and final step usually occurs at the end of an
accounting period. After management has a chance to
look over the entire last period, they can start making
plans for the next year. For example, they will most
likely review the original budget that was created and
why certain goals were set. Then they will compare the
actual with the budgeted performance over the entire
period. Lastly, management will focus on how they tried
to correct the problem operations and develop a plan
to fix them in the next period.
 What is process costing?

• Definition of Process Costing

• Process costing is a term used in cost accounting to describe one method for collecting
and assigning manufacturing costs to the units produced. A processing cost system is used
when nearly identical units are mass produced. (Job costing or job order costing is a
system used to collect and assign manufacturing costs to units that vary from one
another.)
• Example of Process Costing
• Let's assume that a company manufactures large quantities of an identical product. The
product requires several processing operations, each of which occurs in a separate
department. In the first department, the following processing costs were incurred during
the month of June:
• Direct materials of $150,000
• Conversion costs of $225,000
• If the equivalent of 100,000 units were processed in June, the per unit costs will be $1.50
for direct materials and $2.25 for conversion costs. These costs will then be transferred to
second department where its processing costs will be added.
  Activity Based Costing

• Activity based costing (ABC) assigns

manufacturing overhead costs to products in a
more logical manner than the traditional
approach of simply allocating costs on the
basis of machine hours. Activity based costing
first assigns costs to the activities that are the
real cause of the overhead. It then assigns the
cost of those activities only to the products
that are actually demanding the activities.
• et's discuss activity based costing by looking at two products manufactured by
the same company. Product ABC is a low volume item which requires certain
activities such as special engineering, additional testing, and many machine
setups because it is ordered in small quantities. A similar product, Product XYZ, is
a high volume product—running continuously—and requires little attention and
no special activities. If this company used traditional costing, it might allocate or
"spread" all of its overhead to products based on the number of machine hours.
This will result in little overhead cost allocated to Product ABC, because it did not
have many machine hours. However, it did demand lots of engineering, testing,
and setup activities. In contrast, Product XYZ will be allocated an enormous
amount of overhead (due to all those machine hours), but it demanded little
overhead activity. The result will be a miscalculation of each product's true cost
of manufacturing overhead. Activity based costing will overcome this
shortcoming by assigning overhead on more than the one activity, running the
machine.
• Activity based costing recognizes that the special engineering,
special testing, machine setups, and others are activities that
cause costs—they cause the company to consume resources.
Under ABC, the company will calculate the cost of the resources
used in each of these activities. Next, the cost of each of these
activities will be assigned only to the products that demanded the
activities. In our example, Product ABC will be assigned some of
the company's costs of special engineering, special testing, and
machine setup. Other products that use any of these activities will
also be assigned some of their costs. Product XYZ will not be
assigned any cost of special engineering or special testing, and it
will be assigned only a small amount of machine setup.
• Activity Based Costing with Two Activities
• Let's illustrate the concept of activity based costing by looking
at two common manufacturing activities: (1) the setting up of
a production machine for running batches of products, and
(2) the actual production of the units of product.
• We will assume that a company has annual manufacturing
overhead costs of $2,000,000—of which $200,000 is directly
involved in setting up the production machines. During the
year the company expects to perform 400 machine setups.
Let's also assume that the batch sizes vary considerably, but
the setup efforts for each machine are similar.
• The cost per setup is calculated to be $500 ($200,000 of cost per
year divided by 400 setups per year). Under activity based costing,
$200,000 of the overhead will be viewed as a batch-level cost. This
means that $200,000 will first be allocated to batches of products to
be manufactured (referred to as a Stage 1 allocation), and then be
assigned to the units of product in each batch (referred to as 
Stage 2 allocation). For example, if Batch X consists of 5,000 units of
product, the setup cost per unit is $0.10 ($500 divided by 5,000
units). If Batch Y is 50,000 units, the cost per unit for setup will be
$0.01 ($500 divided by 50,000 units). For simplicity, let's assume
that the remaining $1,800,000 of manufacturing overhead is caused
by the production activities that correlate with the company's
100,000 machine hours.