activity based costing

Activity Based CostingActivity Based Costing

activity

based costing


Determining Cost of an Object

IntuitionEducated GuessingConventional CAActivity Based Costing


Total Cost for a Cost Object

Direct Cost (Lab + Mat)+ Overhead Cost=Total Object Cost


CCA ABC&


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


Departmentalization

1 Process of dividing the factory into number of Segments Is called Departmentalization

P1 S1P2 P3 S1

Prod Departments Service Dept.

Conventional Cost Accounting


Departmentalization

2 Process of allocating and apportioning POHEs to different departments or

cost centers (Prod & Service )

P1 S1P2 P3 S1


FactoryOverheads


Departmentalization

P1 S1P2 P3 S1


FactoryOverheads

Allocation &Apportionment


Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)

Operating Department(Machining)

Operating Department(Assembly)

The Products

Absorption


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 unitsProduct B 2 hours of direct labour Direct labour Cost:2 hours x Rs 20= Rs 40 Production=950 units


CCA in an Organization (Contd)…………….

Total Overhead =Rs 1,00,000Total Direct Labour=2000 hours

OH Rate/hr=Rs 1,00,000/2000hours =Rs 50/hourProduct A : 1 hour of direct labourProduct B: 2 hours of direct labour

CCA overhead allocation A: Rs 50 per unit B: Rs100 per unit



CCA may lead to Under Costing & Over Costing

Under absorption -under pricing product

Over absorption - over pricing product



M Course Dessert Drinks Total Rs Rs Rs Rs

Abhishek 110 0 40 150Banke 200 80 140 420Paraveen 150 40 80 270Devinder 140 40 60 240

Total 600 160 320 1080

Average 150 40 80 270


What is noticeable indistribution of Cost?


To avoid thisAmbiguity andunder/over absorptionof costABC is a Good Alternative

Activity Based CostingActivity 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 CostingActivity Based Costing -what is ABC?

An Activity is an event, task or unit of work

with a specified purposeDesigning productsSetting up MachinesOperating MachinesDistributing ProductsAdminister Processes

Activity Based CostingActivity Based Costing System

ActivitiesCosts of

Activities

Assigned toCost Object•Product•Service•Customer According to use

Activity Based CostingActivity Based Costing When to use

When Overhead is High

Products are Diverse: complexity,

Cost of Error is High

Competition is Stiff


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’

few features

Activity Based CostingActivity 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


1 Identify Activities

Set –UPMachiningReceivingPackingEngineering


2 Determine Cost for Each Activity

Set Up- Rs 10,000

Machining - Rs40,000

Receiving- Rs10,000

Packing - Rs 10,000

Engineering- Rs 30,000


3 Determine Cost Drivers

Setup — Number of Setups

Machining —Machine Hours

Receiving – No. of Receipts

Packing —No. of Deliveries

Engineering —No of Hours


4Calulate Activity Rate

Activities Cost Prod A COST Prod B Cost Rs Rs Rs

Set Up 10,000 1no 2500 3no 7500

Machining 40,000 100Hrs 2000 1900Hrs 38000

Receiving 10,000 1 no 2500 3 no 7500

Packing 10,000 1 2500 3 7500Engineering 30,000 500Hrs 15000 500Hrs 15000

1,00,000 24,500 75,500


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



Total Overhead =Rs 1,00,000Total Direct Labour=2000 hours

Rs 1,00,000/2000hours =Rs 50/hour

Product A : 1 hour of direct labourProduct B: 2 hours of direct labour

CCA overhead allocation A: Rs 50 per unit B: Rs100 per unit


Product Cost CCA & ABC…

Cost Of Product A CCA ABC Rs RsOverhead 50 245D Cost 20 20

Total 70 265

Cost Of Product B CCA ABC Rs RsO’head 100 79.47D Cost 40 40.00

Total 140 119.47

Overhead Under absorbed Overhead Over absorbed


How the company should react to this situation?


Distribute Case-dell computer


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 CostingActivity Based Costing question

Two ProductsA & B

SalesA-1000B-25000

Direct Lab HrsA-1 hourB-.60hour

Direct Lab Work4,00,000 DLHPer periods

12 Support Staff Over Head RS 5,00,000

Support Staff Engaged in 3 activities

6 engaged in receiving 25000 consignments of components3 engaged in receiving 10000 consignments of Raw Materials3 engaged in disbursing kits of components & materials for 5000 production runs

Product A Requires

200 Consignments of Components50 Consignments of Raw Materials10 Production runs per period

Product B


Two ProductsA & B

SalesA-1000B-25000

Direct Lab HrsA-1 hourB-.60 hour

Direct Lab Work4,00,000 DLHPer periods

Activity Based CostingActivity Based Costing ABC question

You are required to-

a) Calculate OH Cost of products A& B using CCAb) Identify appropriate cost drivers & calculate the Over Head Cost of A& B using ABCc) Compare answers of A & B

Activity Based CostingActivity Based Costing ABC Solution

Total Overhead Cost =Rs 5,00,000Total Direct Lb. Hours= 4,00,000OH Rate Per Lab Hr =5,00,000/4,00,000 = Rs 1.25 per hour

Products Per Unit Total (Rs) Rs A (1XRS 1.25) 1.25 1000x1.25=Rs1250 B (.6XRs 1.25) 0.75 25000x .75=Rs18750

A) CCA


B)Appropriate Cost Activities

1) Receiving Components

2) Receiving Raw Materials

3) Disbursing Kits of RM & Components

Activity Based CostingActivity Based Costing Solution

B)Cost Of ActivitiesReceiving Components =Rs2,50,000 (500000x6/12)

Receiving Raw Materials=Rs1,25,000

Disbursing R Mat.& Kits = Rs1,25,000


B) OVERHEAD Charging to Product Cost

Products Overhead Allocation Total (Rs) Per Unit (Rs)

A (200X10+50X12.50+10X25) 2,875 2.87

B (100X10+8X12.50+5X25 ) 1,225 0.05

Product A Requires


Product B



Products Total (Rs) Diff Per Unit (Rs) ABC CCA ABC CCA Diff

A) 2,875 1250 1625 2.87 1.25 1.62

B) 1,225 18750 17525 0.05 0.75 .70

Comparison


C)

1) Product cost shown in B are more meaningful than in A)

2) CCA is more of an estimation

3) ABC is more accurate, clear and scientific

Comparison of Two Methods

Activity Based CostingActivity 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 30D Labour(Rs10/Hr) 30 40 50Production 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 twomajor cost pools for production overhead and their associationcost drivers

Activity Based CostingActivity Based Costing Question -2

Activity Cost Pool Cost Driver Cost Of Activities

Receiving/Inspecting/Quality Assurance Purchase Requisition Rs 14,00,000

Production Scheduling/Machine Setups Numbers Of Batches Rs 12,00,000

Further Information

A B C

No of Purchase Requisitions 1200 1800 2000Number of Setups 240 260 300

Calculate cost of ABC products under activity based costingCompare it with CCA

Activity Based CostingActivity Based Costing Answer-2

Activities

ReceivingInspectingQuality Insurance

Purchase Requisition

Activities

Production SchedulingMachine Setups

No. of Batches


Overhead=Rs14,00,000

P Requisitions=5000

Cost per Req= 1400000/5000 =Rs 280 /PR

Overhead = Rs12,00,000Batches Setups = 800

Cost Per setups= 1200000/800 =1500 per setup


A B C

a) Receiving/inspecting/ quality 280 x1200 280 x1800 280x2000 10000 20000 30000

= Rs 33.60 Rs 25.20 =Rs 18.66

b) Prod Scheduling/M Setups 1500x240 1500x260 1500x300 10000 20000 30000

= Rs 36.00 Rs 19.50 Rs 15.00


A(Rs) B (Rs) C(Rs)

Direct Materials 50.00 40.00 30.00Direct Labour 30.00 40.00 50.00Production Overhead a) Receiving/inspecting 33.60 25.20 18.66 b) Scheduling/Setups 36.00 19.50 15.00

Total Cost PU 149.60 124.70 113.66

Activity Based CostingActivity 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 CostingActivity Based Costing benefits

Pricing and Product Mix Decisions

Cost Reduction & Process Improvement Decisions

Design Decisions

Planning & Managing Activities

Activity Based CostingActivity Based Costing limitations

May require Substantial Resources

Benefits must outweigh the additional Cost

May be difficult to apply in certain cases


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activity based costing

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