Activity Based Costing 5 - Cloud Object Storages3.amazonaws.com/.../cdn/forum/files/53_activity_based_costing.pdf · After studying this chapter, you should be able to) ... Activity

After studying this chapter, you should be able to

Discuss the limitations of using only unit-based drivers to assign costs.

Provide a detailed description of activity-based product costing

Explain how homogeneous cost pools can be used to reduce the number of activity rates.

Describe activity-based system concepts including an ABC relational database and ABC software.

Activity Based Costing

Learning Objectives

5

Sec 1_Ch-05_Activity Based Costing.indd 5.1Sec 1_Ch-05_Activity Based Costing.indd 5.1 1/12/2011 3:51:55 PM1/12/2011 3:51:55 PM

5.2 Problems and Solutions: Advanced Management Accounting

INTRODUCTORY THEORYIntroduction

Activity based costing system is a cost accounting system that uses both unit and non-unit based cost drivers to assign costs to cost objects by fi rst tracing costs to activities and then tracing costs from activities to products.

Defi nitions of Important TermsCost Object: Cost object is any item such as products, departments, projects, activities, and so on, for which costs are measured and assigned.Cost Driver: Cost driver is a factor that causes a change in resource usage, activity usage, costs and revenues.Resource Cost Driver: It is a factor that measures the demand placed on resources by activities and is used to assign the cost of resources to activities.Activity Cost Driver: It measures the demands that cost objects place on activities. It is used to assign activity cost to cost objects.

Stages in Activity Based Costing 1. Identify, defi ne, and classify activities and key attributes. 2. Assign the cost of resources to activities. 3. Assign the cost of secondary activities to primary activities. 4. Identify cost objects and specify the amount of each activity consumed by specifi c cost objects. 5. Calculate primary activity rate. 6. Assign activity costs to cost objects.

Classifying ActivitiesTo help identify activity driver and enhance the management of activities, activities are often classifi ed into one of the following four general activity categories: (i) Unit level activities (ii) Batch level activities (iii) Product level activities (iv) Facility level activities

Purpose of ABCABC is used particularly in organisations where: (i) Production overheads are high in relation to direct costs. (ii) There is a great diversity in the product range. (iii) Product use very different amounts of overhead resources. (iv) Overheads are signifi cantly non unit level overheads.

Activity Based Costing System – Installation and OperationThe Motions for Pursuing an ABC Implementation: (i) Removal of product under costing and overcosting for costing accuracy. (ii) For identifi cation and elimination of non value adding activities. (iii) Accurate cost information for decision making.Distinct Practical Stages in the ABC Implementation: 1. Staff training 2. Process specifi cation 3. Activity defi nition 4. Activity driver selection 5. Costing


Activity Based Costing 5.3

Activity Based Cost ManagementActivity based cost management is a system wide, integrated approach that focuses management’s attention on activities with the objective of improving customer value and profi t achieved by providing this value. ABC is the major source of information for activity based management.

ABM Model

SystemsPlanning

Identify, Define,and Classify Activities

PVA ABC

Assign ResourceCost to Activities

Identify Cost Objectsand Activity Drivers

Calculate ActivityRates

ImproveDecisions

ReduceCosts

IncreaseProfitability Assign Costs to

Cost ObjectsSearch for Improvement

Opportunities

Establish ActivityPerformance Measures

Define Root Causesof Each Activity

Assess Value Contentof Activities

Process Value AnalysisProcess value analysis is fundamental to activity based responsibility accounting, focusing on accountability for activities rather than costs, and emphasising the maximisation of system wide performance instead of individual performance. Process value analysis moves activity management from a conceptual basis to an operational basis. Process value analysis is concerned with: 1. Driver analysis – It is effort expended to identify those factors that are root causes of activity costs. 2. Activity analysis – Activity analysis is the process of identifying, describing, and evaluating the activities

that an organisation performs.Activity analysis should produce four outcomes: (i) What activities are performed. (ii) How many people perform the activities. (iii) The time and resources required to perform the activities. (iv) Assessment of the value of the activities to the organisation, including a recommendation to select and

keep only those that add value.



Activities Value added activities Non value added activities ↓ ↓• Activities necessary to remain in the business • There are unnecessary activities• Not valued by internal or external customers • Fails to produce a change in state• Contributes to customer value • Helps to meet organisational needs

In ABC we have 2 Steps: ■ Prepare a Statement of Cost Pool ■ Prepare “Statement of Cost”/“Statement of Overhead cost” as per requirement of question.

Statement of Cost (ABC Technique)

Product A Rs B Rs C Rs Total RsMaterial (identifi ed) Labour (identifi ed) XX XX XX XX Overhead XX XX XX XX XX XX XX XXSet up Cost XX XX XX XX

COST POOL

Overheads Amount Activity No. of Cost Rs. activity activityMachine Rent XX No. of times Usage XX XX purchase XX usageSetup Cost XX No. of Setup/Setup hour XX XX set up Stores XX No. of Required XX XX slip XX Slip/Material Cost/Qty.Inspection Cost XX No. of Set up XX XX Production Rent Packing Charges XX No. of livery XX Others XX Method of absorption XX Cost Driver

Cost Pool means a statement in which all the overheads to be analysed into two parts: ■ Activity oriented over heads. ■ Non activity oriented overheads so that all the overheads called be identifi ed with the product can the basis of their respective activities. Cost Driver means the allocation base with the application of which the overheads can be identifi ed with

the product. Direct Material: 1: Directing traced with production

2: Final quantity increase. 3: Integral and major part.

Indirect material: Used to produced fi nished Good with raw material.

Points to RememberPoints to Remember



ABM is a currently used for a variety of business applications such as: ■ Cost reduction: ABM can reduce costs in four ways: (a) Activity elimination (b) Activity selection (c) Activity reduction (d) Activity sharing ■ Performance measurement: It measures how well an activity was performed and the results achieved.

Measures of activity performance are both fi nancial and non fi nancial and center on three major dimensions: (a) effi ciency, (b) quality, and (c) time.

■ Business process re-engineering: It refers to the performance of a process in a radical way with the objectives of achieving dramatic improvements in response time, quality and effi ciency.

■ Benchmarking: Benchmarking is complimentary to ABM and it can be used as a search mechanism to identify opportunities for improvement. Benchmarking uses best practices found within and outside the organisation as the standard for improving activity performance.

■ Activity based budgeting: Activity based budgeting analyses the resource input or cost for each activity. It provides a framework for estimating the amount of resources required in accordance with budgeted level of activity.

Points to RememberPoints to Remember

Question 1: XYZ Plc manufactures four products, namely A, B, C and D, using the same plant and processes. The following information relates to a production period.

Product Volume Material cost per unit

Direct labour per unit

Machine time per unit

Labour cost per unit

A 500 $5 ½ hour ¼ hour $3B 5,000 $5 ½ hour ¼ hour $3C 6,00 $16 2 hour 1 hour $12D 7,000 $17 2½ hours 1½ hours $9

Total production overhead recorded by the cost accounting system is analysed under the following headlines Factory overhead applicable to machine oriented activity is $ 37,749. Set-up costs are $4250. The cost of ordering materials is $1920 Handling materials- $7560. Administration for spares parts - $8400. These overhead costs are absorbed by products on a machine hour rate of $4.80 per hour, giving an overhead cost per product of: A = $1.20, B = $1.20, C = $ 4.80, D = $7.20 However investigation into the production overhead activities for the period reveals the following totals:

Product Number of set-ups Number of material orders

Number of times Materials was handled

Number of spare parts

ABCD

1628

1414

210 312

2514

Required: 1. To compute an overhead coproduct using activity-based costing, tracing overheads to production units by

means of cost drivers. 2. To comment briefl y on the differences disclosed between overheads traced by the present system and those

traced by activity based costing.



Solution: Statement of Cost Pool (ABC)

Overhead Amount (`) Basis No of Activity Cost per ActivitySet-up cost 4,250 No of set-up 17 [1 + 6 + 6 +2 + 8] 250Ordering cost 1,920 No of order 10 [1 + 4 + 1 + 4 +] 192Handling cost 7,560 No of times 27 [2 + 10 + 3 + 12] 57.77Administration for spare ports 8,400 No of spare ports 12 [2 +5 + 1 + 4] 700

Factory overhead 37,749 Machine hours 12475 [125 + 1250 + 60 + 10500] 3.0259

Statement of Cost Sheet A (`) B (`) C (`) D (`)

(A) Direct material 2,500 25,000 9,600 1,19,000(B) Direct labour 1,500 15,000 7,200 15,300(C) Overhead cost:Set up @ 250 250 1,500 500 2,000Material ordering cost @ 192 192 768 192 768Material handle cost @ 57.77 115 578 173 694Spare parts @ 700 1,400 3,500 700 2,800Factory overhead @ 3.0259 378 3,782 1,816 31,773Total overhead cost (Total C) 2,335 9,228 3,381 38,035(a) Overhead/Unit (ABC) 4.67 1.8456 5.635 5.43357(b) Overhead/Unit (Traditional) 1.20 1.20 4.80 7.2(a – b) difference 3.47 0.6456 0.835 (1.76)

Question 2: A company produces three products A, B and C for which the standard costs and quantities per unit are as follows:

Particulars ProductsA B C

Quantity produced 10,000 20,000 30,000Direct material/p.u.(`) 50 40 30Direct Labour/p.u. (`) 30 40 50Labour hours/p.u. 3 4 5Machine hours 4 4 7No. of purchase requisitions 1,200 1,800 2,000No. of set ups 240 260 300

Production overhead split by departments —Department 1 = ` 11,00,000 —Department 2 = ` 15,00,000Department 1 is labour intensive and department 2 is machine intensive Total labour hours in Department 1 = 1,83,333 Total machine hours in Department 2 = 5,00,000 Production overhead split by activity – Receiving/inspecting ` 14,00,000 Production scheduling/machine set up ` 12,00,000 ` 26,00,000 Number of batches received/ inspected = 5,000 Number of batches for scheduling and set-up = 800



Required: (i) Prepare Product Cost Statement under traditional absorption costing and Activity Based costing Method. (ii) Compare the results under two methods.

Solution: Statement of Cost Pool (Absorption)

Department Cost (`) Basis No. of Activity Cost per ActivityI 1,100,000 Labour hours 1,83,333 6II 15,00,000 Machine hours 5,00,000 3

Statement of Cost (Absorption)A B C Total

Material ` 5,00,000 ` 8,00,000 ` 9,00,000 ` 22,00,000

Labour ` 3,00,000 ` 8,00,000 ` 15,00,000 ` 26,00,000Overhead:

Department I ` 1,80,000 (30,000 × 6)

` 4,80,000 (6 × 80,000)

` 9,00,000 (6 × 1,50,000)

` 15,60,000

Department II ` 1,20,000 (40,000 × 3)

` 2,40,000 (3 × 80,000)

` 630,000 (2,10,000 × 3)

` 9,90,000

Total cost 11,00,000 23,20,000 39,30,000 73,50,000

Statement of Comparative CostActual Budgeted Effect

Department I 11,00,000 15,60,000 4,60,000 (over)Department II 15,00,000 9,90,000 5,10,000 (under)

Statement of Cost Pool [ABC]Overhead Amount (`) Basis No. of Activity Cost per Activity

Receiving and inspection 14,00,000 Requisition 5,000 [1,200 + 1,800 + 2,000] 280Setup 12,00,000 Set up 800 [240 + 260 + 300] 1,500

Statement of Cost as per ABCA (`) B (`) C (`) Total (`)

Material 5,00,000 8,00,000 9,00,000 22,00,000

Labour 3,00,000 8,00,000 15,00,000 26,00,00Overhead:Receiving 3,36,000

(1,200 × 280)5,04,000

(1,800 × 280)5,60,000

(2,000 × 280)14,00,000

Set up cost 3,60,000(240 × 1,500)

3,90,000(260 × 1,500)

4,50,000(260 × 1,500)

12,00,000

Total cost 14,96,000 24,94,000 34,10,000 74,00,000

Statement of Comparative CostA B C

Cost under 14,96,000 24,94,000 34,10,000Cost under traditional 11,00,000 23,20,000 39,30,000Absorption costingDifference 3,96,000 1,74,000 (5,20,000)

Question 3: The following information provides details of costs, volume and cost drivers for a particular period in respect of ABC Ltd; for product X, Y and Z:



Product X Product Y Product Z TotalProduction and sale unit 30,000 20,000 8,000Raw material unit (usage) 5 5 11Direct material cost (`) 25 20 11 12,38,000Direct labour hour 1- 1/3 2 1 88,000Machine hour 1 – 1/3 1 2 76,000Direct labour cost (`) 8 12 6No. of Production Runs 3 7 20 30No. of deliveries 9 3 20 32No. of receipts ( 2 × 7) 15 35 220 270No. of production orders 15 10 25 50

Overhead costs:Set-up 30,000Machines 7,60,000Receiving 4,35,000Packing 2,50,000Engineering 3,73,000

` 18,48,000 The Company operates a just-in-time inventory policy and received each component once per production run. In the past the company has allocated overheads to products on the basis of direct labour hours. However the majority of overheads are related to machine hours rather than direct labour hours. The company has recently redesigned its cost system by recovering overheads using two volume related bases: Machine hours and a material handling overhead rate for recovering overheads of the receiving department. Both the current and the previous cost system reported low profi t margins for product X, which is the company’s highest-selling product. The management accountant has recently attended a conference on activity-based costing and the overhead costs for the last period have been analyzed by the major activities in order to compute activity-based costs.

Required: (a) Compute the product costs using a traditional volume-related costing system based on the assumption that: (1) All overheads are recovered on the basis of direct labour hours ( i.e. the company past product costing

system.). (2) The overheads of the receiving department are recovered by a materials handling overhead rate and

the remaining overheads are recovered using a machine hour rate (i.e. the company current costing system).

(b) Compute product costs using an activity based costing system.

Solution: 1 (a) Statement of cost pool [Absorption] Overhead cost = ` 184,8000 Direct labour hours = 88,000 hrs (40000 + 40,000 + 8000] Overhead cost per labour hours = 21 per hours

Statement of Cost (Absorption)Particulars Product

X (`) Y (`) Z (`) Total (`)Material 7,50,000 4,00,000 88,000 12,38,000Labour 2,40,000 2,40,000 48,000 5,28,000Overhead 8,40,000

(21 × 40,000)8,40,000

(21 × 40,000)1,68,000

(21 × 800)18,48,000

Total 18,30,000 1,48,0000 3,04,000 36,14,000



1 (b) Statement of Cost Pool (Absorption]

Overhead Amount Basis Quantity Cost/Qty.Receipts 4,35,000 no. of receipt 270 (15 + 35 + 220] 1,611.1Others 14,13,000 machine hours 76,000 (40,000 + 20,000 + 16,000) 18.59

Statement of Cost (Absorption)X (`) Y (`) Z (`) Total (`)

Material 7,50,000 4,00,000 88,000 12,38,000Labour 2,40,000 2,40,000 48,000 5,28,000Overhead:

Receipts 24,167 56,389 3,54,444 4,35,000Others 7,43,600 7,31,800 2,97,440 17,72,840Cost 17,57,767 14,28,189 7,87,884 39,73,840

Statement of Cost Pool (ABC)Overhead Amount (`) Basis No. of Activity Cost per Activity (`)Setup 30,000 No. of set up 30 (3 + 7 + 20) 1000Machine 7,60,000 Machine hour 76,000 (40,000 + 20,000 + 1,600) 10Receiving 4,35,000 No. of receipt 270 (15 + 35 + 220) 1,611.11

Packing 4,35,000 No. of receipt 32 (9 + 3 + 20) 7,812.5Engineering 3,73,000 No. of order 50 (15 + 10 + 25) 7,460

Statement of Cost (ABC)Particulars X (`) Y (`) Z (`) Total (`)

Material 7,50,000 4,00,000 88,000 12,38,000Labour 2,40,000 2,40,000 48,000 5,28,000Overhead:Setup @ 1000 3,000 7,000 20,000 30,000Machine @ 10 4,00,000 2,00,000 16,00,000 7,60,000Receiving @ 1111.11 24,167 56,389 3,54,444 4,35,000 Engineering @ 7460 1,11,900 74,600 1,86,500 37,000Cost 15,99,380 10,01,426 10,13,194 36,14,000

Question 4: G Ltd. produces four products. A conventional product costing system is used at present. Now, use an activity based costing (ABC) system is being considered. Details of the four products and relevant information are given below for one period:Product A B C DOutput in units 240 200 160 240Costs per unit ` ` ` `

Direct material 80 100 60 120Direct labour 56 42 28 42Machine hours (per unit) 8 6 4 6

The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows:

Particulars Amount (`)Machine department costs (Rent dep. and supervision) 20,860Set-up costs 10,500Stores receiving 7,200Inspection/quality control 4,200Output handling and dispatch 9,240

52,000



The cost drivers to be used for the overhead costs are as listed below:Cost Cost DriverSet up costs Stores receiving Inspection/Quality control Output handling and dispatch

Number of production runs Requisitions raised Number of production runs Orders executed

The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 84, each order being for a batch of 10 of a product.

Required: (a) to calculate the total costs for each product if all overhead costs are absorbed on a machine hour basis; (b) to calculate the total costs for each product, using activity-based costing system; (c) to calculate and list the unit product costs from your fi gures in (a) and (b) above, to show the differences and to

comment briefl y on any conclusions which may be drawn which could have pricing and profi t implications.

Solution: Statement of Cost Pool

Overhead Amount Basis No. of Activity Cost per ActivityMachine 20,860 Machine hours 5,200 (1,920 + 1,200 + 640 + 1,440) 4.01Setup cost 10,500 No. of set-up 42 (12 + 10 + 8 + 12) 250Store 7,200 No. of requisition 80 (20 + 20 + 20 + 20) 90Inspection 4,200 No. of purchase order 42 (12 + 10 + 8 + 12) 100Output handling and dispatch 9,240 No. of order 84 (24 + 20 + 16 + 24) 110

Statement of Cost (ABC)Cost A (`) B (`) C (`) D (`) Total (`)

Material 19,200 (80 × 240) 20,000 (200 × 100) 9,600 (160 × 60) 28,800 (240 × 120) 77,600Labour 13,440 (240 × 56) 8,400 (200 × 42) 4,480 (160 × 28) 10,080 (240 × 42) 36,400

OverheadSetup 3,000 (12 × 250) 2,500 (10 × 250) 2,000 (8 × 250) 3,000 (12 × 250) 10,500

Store 1,800 1,800 1,800 1,800 7,200Inspection 1,200 1,000 800 1,200 4,200Output handlings and dispatch

2,640 2,200 1,760 2,640 9,240

Machine 7,699 (1,920 × 4.01)

4,812 (1,200 × 4.01)

2,566 (640 × 4.01)

5,783 (1,440 × 4.01)

20,860

Total cost 48,979 40,712 23,006 53,303 1,66,000

Statement of Cost Pool (Absorption) Overhead = ` 52,000 Machine hours = 5,200 (1,920 + 1,200 + 640 + 1,440) Cost per machine hour = 10

Statement of CostA (`) B (`) C (`) D (`) Total (`)

Material 19,200 20,000 9,600 28,800 77,600

Labour 13,440 8,400 4,480 10,080 36,400Overhead @ 10 19,200

(1,920 × 10)12,000

(1,200 × 10 )6,400

(640 × 10)14,400

(1,440 × 10)5,200

Cost 51,840 40,400 20,480 53,200 1,66,000



Statement of ReconciliationA B C D Total

ABC (`) 48,979 40,712 23,006 53,303 1,66,000Absorption (`) 51,840 40,400 20,480 53,280 1,66,000Difference (2,861) 312 2,526 23 nil

The difference of distribution of the overhead occurred due to the following reasons: (i) The ratio of difference activity between the products are different from the ratio of single recovery rate

basis. (ii) The product which consumes high volume of activity as compared to machine working hours will absorb

high volume of overhead. (The total value of overhead remains same).

Question 5: Repak Ltd is a warehousing and distribution stores the products and then re-packs them for distribution as required. There are three customers for whom the service is provided: John Ltd., George Ltd and Paul Ltd. The products from all three customers are similar in nature but of varying degrees of fragility. Basic budget information has been gathered for the year to 30 June and is shown in the following table:

Products handled (cubic meter)

John Ltd. 30,000

George Ltd. 45,000

Paul Ltd. 25,000

Costs

($000)

Packing materials 1,950

(see Note –1)

Labour-Basic 350

Overtime 30

Occupancy 500

Administration and management 60

Note 1: Packaging materials are used in re-packing each cubic meter of product for John Ltd, George Ltd and Paul Ltd in the ratio 1:2:3 respectively. This ratio is linked to the relative fragility of the goods for each customer.Note 2: Additional information has been obtained in order to enable unit costs to be prepared for each of the three customers using an activity-based costing approach. The additional information for the year to 30 June has been estimated as follows: 1. Labour and overhead costs have been identifi ed as attributable to each of three work centers receipt and

inspection, storage and packing as follows:

Cost Allocation Proportions

Receipts and inspection

Storage Packing

% % %Labour-basic 15 10 75Overtime 50 15 35Occupancy 20 60 20Administration and management 40 10 50

(iii) Studies have revealed that the fragility of different goods affects the receipts and inspection time needed for the products for each customer. Storage required is related to the average size of the basic incoming product units from each customer. The re-packing of goods for each customers have been evaluated as follows (All Data are provided for each cubic meter for each customer).



John Ltd. George Ltd. Paul Ltd.

Receipt and inspection (minutes) 5 9 15Storage (square meters) 0.3 0.3 0.2Packing (minutes) 36 45 60

Required: A: Calculate the budgeted average cost per cubic mater of packaged products for each customer for each of the

following two circumstances: 1. Where only the basic budget information is to be used. 2. Where the additional information enables an activity-based costing Approach to be applied.

(ICWA Final 1988)

Solution: Statement of Cost Pool (Basis budget)

Cost Amount (`) Basis No. of Activity Cost per Activity

Packing material 19,50,000 Composite Ratio 1,950 (30:90:75 W.N.) 10,000

Other 9,40,000 Quantity 1,00,000 (30,000 + 45,000 + 25,000) 9.4

Statement of CostJohn Ltd. George Ltd. Raul Ltd.

Quantity 30,000 45,000 25,000Packing material (30:90:75) ` 3,00,000 ` 9,00,000 ` 7,50,000Other cost ` 2,82,000

(9.4 × 30,000)` 4,23,000

(9.4 × 45,000)` 2,35,000

(9.4 × 25,000)Total Cost ` 5,82,000 ` 13,23,000 ` 98,5,000

2. Department of OverheadInspection Storage Packing

Labour 52,500 35,000 3,63,500Overtime 15,000 4,500 10,500Occupancy 1,00,000 3,00,000 1,00,000Administration & management 24,000 6,000 30,000Total 1,91,500 3,45,500 4,03,000

Statement of Cost Pool (ABC)Activities Amount (`) Base

Inspection 1,91,500 9,30,000(1,50,000 + 4,05,000 + 3,75,000)[(5 × 30,000) + (4,500 × 9) + (2,500 × 15)]

Storage 3,45,500 27,500 (9,000 + 13,500 + 5,000)]

Packing 4,03,000 46,05,000 (1,08,000 + 20,25,000 + 1,50,0000)

Statement of Cost (Additional Production)John George (`) Paul (`)

Packing 3,00,000 9,00,000 7,50,000Receiving & Inspection 30,887 83,395 77,218Storage 1,13,073 1,69,609 62,818Packing 94,515 1,77,215 1,31,270Total 5,38,475 13,30,219 10,21,306Cost/unit 17.95 29.56 40.85

53847530,000

⎛ ⎞⎜ ⎟⎝ ⎠

133021929.56

⎛ ⎞⎜ ⎟⎝ ⎠

102130625000

⎛ ⎞⎜ ⎟⎝ ⎠



Working Notes:John George Paul

Ratio of packing material used 1 2 3Qty. 30,000 45,000 25,000Relative composite material ratio 30,000 90,000 75,000Ratio: 30: 90: 75

Question 6: A company manufactures several products of varying levels of designs and models. It uses a single overhead recovery rate based on direct labour hours. The overheads incurred by the company in the fi rst half of the year are as under:

Particulars `

Machine operation expenses 10,12,500

Machine maintenance expenses 1,87,500

Salaries of technical staff 6,37,500

Wages and Salaries of stores staff 2,62,500

During this period, the company-introduced activity based costing system and the following signifi cant activities were identifi ed: • Receiving materials and components • Set up of machines for production runs • Quality inspection. It is also determined that: • The machine operation and machine maintenance expenses should be apportioned between stores and

produc tion activity in 20:80 ratio. • The technical staff salaries should be apportioned between machine maintenance, set up and quality

inspection in 30:40:30 ratio. The consumption of activities during the period under review are as under: • Direct labour hours worked 40,000 • Direct wage rate ` 6 per hour • Production set-ups 2,040 • Material and component consignments received from suppliers 1,960 • Number of quality inspections carried out 1,280 The data relating to two products manufactured by the company during the period are as under:

ParticularsProducts

P QDirect material costs ` 6,000 ` 4,000Direct labour hours 960 100Direct material consignment received 48 52Production runs 36 24Number of quality inspection done 30 10Quantity produced (units) 15,000 5,000

A potential customser has approached the company for the supply of 24,000 units of a component K to be delivered in lots of 3,000 units per quarter. The job will involve as initial design cost of ̀ 60,000 and the manufacture will involve the following per quarter:Direct material costs ` 12,000

Direct labour hours 300

Production runs 6

Inspection 24

Number of consignment of direct materials to be received 20

The company desired a mark up of 25% on cost.



Required: 1. Calculate the cost of product P and Q based on the existing system of single overhead recovery rate. 2. Determine the cost of products P and Q using activity based costing system. 3. Compute the sales value per quarter of component K using activity based costing system.

(C.A. Final May 2003)SolutionL

Statement of Cost PoolOverhead Amount ` Basis No. of Activities Cost per Activity

Stores 2,78,250 + 2,62,500 No. of receipt 1,960 (48 + 52 + …) 275.89Setup 2,55,000 + 11,13,000 Inspection 1,280 (30 + 10 +…) 149.41

Statement of Cost for the Products P and QP (`) Q (`)

Cost: Material 6,000 4,000Labour 5,760 (960 × 6) 600 (100 × 6)Overhead:

Production 24,138 (670.5 × 36) 16,092 (670.5 × 24)Stores 13,242.72 (275.89 × 48) 14,346.28 (275.89 × 52)Inspection 4,482.3 (149.41 × 300 1,494.10 (149.41 × 10)Total cost 53,623.02 36,532.38

Statement of Cost Pool (Absorption) Overhead = ` 21,00,000 Labour hours = 40,000 (960 + 100 + ) Overhead/hour = 52.50(iii) Statement of Cost and Selling Price per Quarter (ABC)

Qty: 3000 (`)Material 12,000Labour 300 × 6 1,800

Avoidable overhead60,000Desige x3000

24⎛ ⎞⎜ ⎟⎝ ⎠

7500

Overhead:Store (275.89 × 20)Prod. (670.5 × 6)Quality inspection (149.41 × 24) 13,128Total cost 34,428Profi t (25%) 8,607Sale value 43,035Selling Price P.U. 14.345

Working NotesMachine material Set-up Quantity Inspection

30% 40% 30%Salary of technical staff (637500) 19,14,250 2,55,000 1,91,250



Machine mainte6nance and operation 1,91,250 + 10,12,500

1,87,500Total 1,39,125It can be distributed into store and production in the ratio of 20%: 80%i.e. Store = 2,78,250Production = 11,13,000

Question 7: Change with Times Ltd. has been manufacturing and selling 4 products A,B,C and D — A & B in its production department X and C & D in its production department Y. Product A is a standard product which is produced for one customer, according to the requirements of a long term contract. Products B and C are produced largely in response to orders received from a small number of customers, but limited numbers are produced for inventory. Product D is produced in a range of different colors and is usually produced for stock with orders being dispatched from warehouse, as required. The company is thinking of going to a new product line. In this process, it may even discontinue one of the existing products after ascertaining the individual product costs and its profi tability. The following data collected pertain to a six months period:

Product Department X Department YA B Total C D Total

Units produced and sold 1,000 800 1,000 500Selling price (`) 27.50 30.00 30.00 35.00Sales revenue (`) 27,500 24,000 51,500 30,000 17,500 47,500Cost incurred (`)Direct material 10,000 6,400 16,400 9,000 7,500 16,500Direct labour 3,000 1,600 4,600 3,000 1,000 4,000

21,000 20,500

` `

Factory Overhead Service department costSet up 1,370 Purchasing 4,440Supervision 2,400 Warehouse & dispatch 3,100Machines 19,800 Power 3,300

23,570 10,840Selling expenses 7,920

Following the usual practice of allocating all the factory overheads and service departments costs using a blanket rate of 400% of unit direct labour cost and the selling expenses as 8% of unit selling price, the unit profi t is worked out as:

ParticularsProduct

A B C DProfi t per unit (`) 0.30 9.60 3.60 7.20

The Cost Accountant of the company considering that using a blanket rate for common cost allocation will always be misleading. As all the operations are predominantly machine operation, arriving at a machine hour rate for each department for allocating the common costs to the products, he fi nds that each product requires one half an hour of machine time. During the period the machines are used for 1,650 hours–900 in X and 750 in Y. Going into details the Cost Accountant makes a fresh calculation and arrives at the unit profi tability of the products under:

ParticularsProduct

A B C DProfi t per unit (`) 2.20 7.50 4.78 4.38



His calculation is based on the following details: Allocation of Common Costs (`)Factory Overheads Total X Y

Set up 1,370 470 900

Supervision 2,400 1,200 1,200

Machines 19,800 10,800 9,000

Service Department Cost

Purchasing 4,440 to be allocated on material costs

Warehouse and dispatch 3,100 on units produced

Power plant 3,300 on hours of usage of machines

The Management Accountant who has joined the company recently is not at all satisfi ed with the Cost Accountant’s calculation. He feels that an important decision to drop a product cannot be taken based on those fi gures. He is of the view that a more refi ned technique is required and when details are available, why not do an activity based costing:

With this end in view, he collects the following details:Activity Cost-pools Amount (`)

Set up 1,370

Supervision 2,400

Machines 19,800

Order processing 440

Material handling 4,000

Finished goods storage 1,600

Dispatch 1,500

Power 3,300

Selling expenses 7,920

Cost DriversParticulars A B C D

Production batch size (units) 100 50 100 25

Set up time (hrs.) 1.5 2 1 4

Supervisor’s time per period (hrs.) 75 40 75 50

Machine timer per unit (hrs.) 0.5 0.5 0.5 0.5

Orders processed per period 10 20 20 60

Raw materials inputs per unit 2 5 2 4

Average holding of fi nished goods (unit) 0 100 100 200

No. of deliveries per period 10 40 50 200

Sales staff time per period (hrs.) 30 160 200 400

With the help of these fi gures, he makes that allocation activity based and produces a profi t statement for submis-sion to management.

Required: Prepare the product profi tability statement based on – (a) the blanket rate, (b) the machine hour rate as the Cost Accountant has done, (c) activity based costing as suggested by the Management Accountant.

(ICWA Final Dec. 1994)



Solution: 1. Statement of Profi t (Absorption)

A (`) B (`) C (`) D (`) Total (`)

Material 10,000 6,400 9,000 7,500 32,900Direct labour 3,000 1,600 3,000 1,000 8,600Factory overhead (34410) 12,003 6,402 12,003 4,002 34,410Selling expenses 2,200 1,920 2,400 1,400 7,920Total cost 27,203 16,322 26,403 13,902 83,830

Selling price 27,500 24,000 30,000 17,500 99,000Profi t 297 7678 3597 3,598 15,170

Note: Under recovery and over recovery exist only when actual base is different from budgeted base.

2. Statement of Profi t (Machine Hour Base)A (`) B (`) C (`) D (`)

Material 10,000 6,400 9,000 7,500Labour 3,000 1,600 3,000 1,000Overhead 10,095 (500 × 20.19) 8,076 (400 × 20.19) 10,820 (500 × 21.648) 5,410 (250 × 21.648)

Setup 2,200 1,920 2,400 1,400Total cost 25,295 17,996 25,220 15,310Selling price 27,500 24,000 30,000 17,500Profi t 2,205 6,004 4,780 2,190

Statement of Machine HoursX Y Total

Setup 470 900 1,370Supervision 1,200 1,200 2,400Machines 10,800 9,000 19,800Warehouse 1,691 1,409 3,100Purchasing 2,213 2,227 4,440Power plant 1,800 1,500 3,300Total 18,174 16,236 34,410Machine hrs. 900 780 1,650Rate 20.19 21.64 20.85

3. Statement of Cost PoolOverhead Amount Basis No. of Activity `

Set up 13.70 Set-up 137 (15 + 32 + 10 + 80) 10Supervision 2,400 Supervision Hr 240 (75 + 40 + 75 + 50) 10Machine 19,800 Machine hour 1,650 (500 + 400 + 500 + 250) 10Ordering price 440 Order 110 (10 + 20 + 20 + 60) 4Material handling 4,000 Raw mat. input 10,000 (200 + 4000 + 2,000 + 2,000) 0.4Finished goods 1,600 Av. holding 400 (0 + 100 + 100 + 200) 4Dispatch 1,500 Delivery 400 (10 + 40 + 50 + 200) 3.75Poser 3,300 Machine hrs 1,650 (500 + 400 + 500 + 250) 2Selling expenses 7,920 Sale staff 790 (30 + 160 + 200 + 400) 10.0253



4. Statement of Profi t (ABC)A (`) B (`) C (`) D (`)

Material 10,000 6,400 9,000 7,500

Labour 3,000 1,600 3,000 1,000

Overhead:

Setup 150 (15 × 10) 320 (32 × 10) 100 (10 × 10) 800 (80 × 10)

Supervision 750 (750 × 10) 400 (40 × 10) 750 (75 × 10) 500 (50 × 10)

Machine 6,000 (500 × 12) 4,800 (400 × 12) 6,000 (500 + 12) 3,000 (250 × 12)

Ordering price 40 (4 × 10) 80 (4 × 20) 80 (4 × 20) 240 (4 × 60)

Material handling 800 (2,000 × .4) 1,600 (4000 × .4) 800 (2000 × 0.4) 800 (2000 × 0.4)

Finished (0 × 4) 400 (4 × 100) 400 (4 × 100) 800 (4 × 200)

Dispatch 37.5 (3.75 × 10) 150 (3.75 × 40) 187.5 (3.75 × 50) 750 (3.75 × 200)

Power 1,000 800 1,000 500

Selling 300.76 (30 × 10.0253) 1,604 (10.0253 × 160) 2,005 (10.0253 × 200) 4,010.24 (10.0253 × 400)

Total cost 22,078.26 18,154 23,322.5 19,900.24

Sale value 27500 24500 30,000 17500

Profi t 5,421.74 5,846 6,677.5 (2,400.24)

Question 8: The Excel Ltd. make and sell two products,V4 and V2. Both products are manufactures through two consecutive process-making and packing raw materials is input at the commencement of the making process. The following estimated information is available for the period ending 31 March.

Making Packing

Conversion cost ($000) ($000)

Variable 350 280

Fixed 210 140

40% of fi xed costs are product specifi c, the remainder are company fi xed costs. Fixed Costs will remain un-changed throughout a wide activity range.

Product information V4 V2

Production time per unit

Making (minutes) 5.25 5.25

Packing (minutes) 6 4

Production sales (units) 5,000 3,000

Selling price per unit($) 150 180

Direct material per unit (S) 30 30

(iii) Conversion costs are absorbed by products using estimated time based rates.

Required: (a) Using the above information, Calculate unit costs for each product, analysed as relevant. (b) Comment on a management suggestion that the production and sale of one of the product should not proceed

in the period ending 31 March. (c) Additional information is gathered for the period ending 31 March has follows: (i) The proportion of product specifi c conversion costs (variable and fi xed) are analysed as follows: Making Process: moulding (60%); trimming (40%) Packing Process; conversion (70%), Packing material (30%)



(ii) The making process consist of two consecutive activities, mounding and trimming.The moulding variable and product fi xed cost conversion costs are incurred in proportion to the temperate required in the moulds. The trimming conversion variable and product fi xed costs are incurred in proportion to the consistency of the material. The variable and Product fi xed packing process conversion cost are incurred in proportion to the time required for each product. Packing materials (which are part of the variable packing cost) requirements depends on the complexity of packing specifi ed for each product.

(iii) An investigation into the effect of the cost drivers on costs has indicated that the proportions in which the total product specifi c conversion costs are related to V4 and V2 are as follows:

V4 V2Temperature (moulding) 2 1Material consistency (trimming) 2 5Time (packing) 3 2Packing (complexity) 1 3

(iv) Company fi xed costs is apportioned to product at an overall average rate per product unit based on the estimated fi gures.

Required: Calculate amended unit costs for each product where activity based costing is used and company fi xed costs are apportioned as detailed above.

Solution: Statement of Cost Pool

Conversion $ Basis No. of Activity Cost per ActivityMaking: Variable 3,50,000 Time minute 42,000 [(5.25 × 5000) + 5.25 × 3000)] 8.33Avoid: Fixed cost 84,000 Time 42,000 2Unavoidable overhead 1,26,000 Time 42,000 3Packing:Variable 28,000 Time 42,000 6.66Fixed unavoidable 84,000 Time 42,000 2Fixed avoidable 56,000 Time 42,000 1.33

Statement of Cost and RevenueV4 (`) V2 (`) Total (`)

Material cost 1,50,000 90,000 2,40,000Conversion cost:(i) Making;Variable cost 2,18,750

(8.3 × 5,000 × 5.25)1,31,250

(8.3 × 15,750)3,50,000

Avoidable fi xed cost 52,500(2 × 26,250)

80,000(6.60 × 12,000)

2,80,000

Fixed cost 40,000(30,000 × 1.3)

16,000(12,000 × 1.3)

56,000

Relevant cost 6,61,250 3,48,750 10,10,000Sale 7,50,000 5,40,000 12,90,000Benefi t 88,750 1,91,250 2,80,000Unavoidable fi xed cost:Packing 78,750

(26,250× 3)47,250

(3 × 15,750)1,26,000

Making (2 × 30,000) 6,00,000 (2 × 12,000) 24,000 84,000Profi t 50,000 1,20,000 70,000

Decision: It is not advisable to discontinue the product V4 because unavoidable fi xed cost 78,750 + 60,000, i.e. 1,38,750 remains constant. Hence, we can say that such fi xed cost can be termed as fi xed cost.


Activity Based Costing 5 - Cloud Object Storages3.amazonaws.com/.../cdn/forum/files/53_activity_based_costing.pdf · After studying this chapter, you should be able to) ... Activity

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