Activity Based Costing5 Learning Objectives 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. Sec 1_Ch-05_Activity Based Costing.indd 5.1 1/12/2011 3:51:55 PM (ii) There is a great diversity in the product range. Calculate primary activity rate. and so on. 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.indd 5. Activity definition 4. Identify. Assign the cost of resources to activities. 4. 3. Activity Based Costing System – Installation and Operation The Motions for Pursuing an ABC Implementation: (i) Removal of product under costing and overcosting for costing accuracy. 5. and classify activities and key attributes. Assign activity costs to cost objects. Cost Driver: Cost driver is a factor that causes a change in resource usage. for which costs are measured and assigned. Identify cost objects and specify the amount of each activity consumed by specific cost objects. activities. Assign the cost of secondary activities to primary activities. projects. Definitions of Important Terms Cost Object: Cost object is any item such as products.5.2 Problems and Solutions: Advanced Management Accounting INTRODUCTORY THEORY Introduction 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 first tracing costs to activities and then tracing costs from activities to products.2 1/12/2011 3:51:57 PM . Process specification 3. (iii) Product use very different amounts of overhead resources. costs and revenues. Stages in Activity Based Costing 1. Classifying Activities To help identify activity driver and enhance the management of activities. activity usage. (ii) For identification and elimination of non value adding activities. activities are often classified 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 ABC ABC is used particularly in organisations where: (i) Production overheads are high in relation to direct costs. departments. 2. Activity Cost Driver: It measures the demands that cost objects place on activities. Activity driver selection 5. (iv) Overheads are significantly non unit level overheads. 6. define. Costing Sec 1_Ch-05_Activity Based Costing. Staff training 2. Distinct Practical Stages in the ABC Implementation: 1. (iii) Accurate cost information for decision making. It is used to assign activity cost to cost objects. 2. Sec 1_Ch-05_Activity Based Costing. (ii) How many people perform the activities. ABM Model Systems Planning Identify. describing. and evaluating the activities that an organisation performs. Activity analysis should produce four outcomes: (i) What activities are performed. integrated approach that focuses management’s attention on activities with the objective of improving customer value and profit achieved by providing this value.indd 5. Driver analysis – It is effort expended to identify those factors that are root causes of activity costs. and Classify Activities PVA ABC Assess Value Content of Activities Assign Resource Cost to Activities Define Root Causes of Each Activity Reduce Costs Establish Activity Performance Measures Improve Decisions Identify Cost Objects and Activity Drivers Calculate Activity Rates Search for Improvement Opportunities Increase Profitability Assign Costs to Cost Objects Process Value Analysis Process value analysis is fundamental to activity based responsibility accounting. Process value analysis moves activity management from a conceptual basis to an operational basis.3 Activity Based Cost Management Activity based cost management is a system wide.Activity Based Costing 5.3 1/12/2011 3:51:57 PM . (iv) Assessment of the value of the activities to the organisation. ABC is the major source of information for activity based management. (iii) The time and resources required to perform the activities. focusing on accountability for activities rather than costs. Process value analysis is concerned with: 1. Define. Activity analysis – Activity analysis is the process of identifying. and emphasising the maximisation of system wide performance instead of individual performance. including a recommendation to select and keep only those that add value. of times Usage No.4 Problems and Solutions: Advanced Management Accounting Activities Value added activities ↓ • Activities necessary to remain in the business • Not valued by internal or external customers • Contributes to customer value Non value added activities ↓ • There are unnecessary activities • Fails to produce a change in state • Helps to meet organisational needs Points to Remember 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.5.4 1/12/2011 3:51:57 PM . Statement of Cost (ABC Technique) Product Material (identified) Labour (identified) Overhead Set up Cost COST POOL Overheads Machine Rent Setup Cost Stores Inspection Cost Packing Charges Others Amount Rs. ■ Non activity oriented overheads so that all the overheads called be identified with the product can the basis of their respective activities. Direct Material: 1: Directing traced with production 2: Final quantity increase. No. Sec 1_Ch-05_Activity Based Costing. of Set up Production Rent No. Cost Driver means the allocation base with the application of which the overheads can be identified with the product. Indirect material: Used to produced finished Good with raw material. of Required Slip/Material Cost/Qty. of livery Method of absorption No. of Setup/Setup hour No. XX XX XX XX XX XX XX XX Activity No.indd 5. 3: Integral and major part. of activity XX XX XX XX XX XX XX Cost Driver Cost activity XX purchase usage XX set up XX slip A Rs XX XX XX XX B Rs XX XX XX XX C Rs XX XX XX XX Total Rs XX XX XX XX Cost Pool means a statement in which all the overheads to be analysed into two parts: ■ Activity oriented over heads. ■ Benchmarking: Benchmarking is complimentary to ABM and it can be used as a search mechanism to identify opportunities for improvement.20. Question 1: XYZ Plc manufactures four products. Product A B C D Volume 500 5. Administration for spares parts . The following information relates to a production period. quality and efficiency. To compute an overhead coproduct using activity-based costing. 2. Benchmarking uses best practices found within and outside the organisation as the standard for improving activity performance. ■ 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. Set-up costs are $4250. tracing overheads to production units by means of cost drivers. ■ Activity based budgeting: Activity based budgeting analyses the resource input or cost for each activity. To comment briefly on the differences disclosed between overheads traced by the present system and those traced by activity based costing.000 Material cost per unit $5 $5 $16 $17 Direct labour per unit ½ hour ½ hour 2 hour 2½ hours Machine time per unit ¼ hour ¼ hour 1 hour 1½ hours Labour cost per unit $3 $3 $12 $9 Total production overhead recorded by the cost accounting system is analysed under the following headlines Factory overhead applicable to machine oriented activity is $ 37.000 6.80. and (c) time. D = $7. (b) quality.Activity Based Costing 5.20. It provides a framework for estimating the amount of resources required in accordance with budgeted level of activity. These overhead costs are absorbed by products on a machine hour rate of $4. C and D.indd 5. B = $1.80 per hour.$8400.20 However investigation into the production overhead activities for the period reveals the following totals: Product A B C D Number of set-ups 1 6 2 8 Number of material orders 1 4 1 4 Number of times Number of spare parts Materials was handled 2 10 3 12 2 5 1 4 Required: 1. using the same plant and processes. C = $ 4.5 1/12/2011 3:51:57 PM . Measures of activity performance are both financial and non financial and center on three major dimensions: (a) efficiency.5 Points 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.00 7. The cost of ordering materials is $1920 Handling materials. B. namely A.749.$7560. Sec 1_Ch-05_Activity Based Costing. giving an overhead cost per product of: A = $1. 800 31.500 1.00.381 5.00.47 1.500 B (`) 25. of set ups 10.0259 Total overhead cost (Total C) (a) Overhead/Unit (ABC) (b) Overhead/Unit (Traditional) (a – b) difference 250 192 115 1.000 Number of batches for scheduling and set-up = 800 Sec 1_Ch-05_Activity Based Costing.000 300 Production overhead split by departments —Department 1 = ` 11.000 40 40 4 4 1.20 0.43357 7.835 2.indd 5.2 (1.200 240 Products B 20.228 1.782 9.400 37. (`) Labour hours/p.5.600 7.500 768 578 3.00.000 30 50 5 7 2.0259 Statement of Cost Sheet A (`) (A) Direct material (B) Direct labour (C) Overhead cost: Set up @ 250 Material ordering cost @ 192 Material handle cost @ 57.20 3.800 260 C 30.77 700 3.816 3. Machine hours No.300 Question 2: A company produces three products A.000 Production overhead split by activity – Receiving/inspecting ` 14.000 C (`) 9.000 15.00.000 15.000 Department 1 is labour intensive and department 2 is machine intensive Total labour hours in Department 1 = 1.6456 500 192 173 700 1.67 1.773 38.(`) Direct Labour/p.333 Total machine hours in Department 2 = 5.6 1/12/2011 3:51:58 PM .035 5.u.000 —Department 2 = ` 15.8456 1.00.u.83.000 50 30 3 4 1.80 0.00.560 8.749 Basis No of set-up No of order No of times No of spare ports Machine hours No of Activity 17 [1 + 6 + 6 +2 + 8] 10 [1 + 4 + 1 + 4 +] 27 [2 + 10 + 3 + 12] 12 [2 +5 + 1 + 4] 12475 [125 + 1250 + 60 + 10500] Cost per Activity 250 192 57. B and C for which the standard costs and quantities per unit are as follows: Particulars A Quantity produced Direct material/p.19.635 4.400 378 2.77 Spare parts @ 700 Factory overhead @ 3.500 3.000 768 694 2.000 ` 26. of purchase requisitions No.920 7.u.76) 2.000 Number of batches received/ inspected = 5.335 4.000 Production scheduling/machine set up ` 12.250 1.200 D (`) 1.6 Problems and Solutions: Advanced Management Accounting Solution: Statement of Cost Pool (ABC) Overhead Set-up cost Ordering cost Handling cost Administration for spare ports Factory overhead Amount (`) 4. 60.00.000 Budgeted 15.00.00.000 3.60.000 (under) Statement of Cost Pool [ABC] Overhead Receiving and inspection Setup Amount (`) 14.000 5.50.50.10.00.00.100.74.000) 23.200 + 1.000 × 6) ` 1.000 [1.00.00.40.000] 800 [240 + 260 + 300] Cost per Activity 280 1.000 (5.000 (2.000 15.000 ` 4.000 C ` 9.000 73.000 ` 5.90.000 B ` 8.00.indd 5.000 (240 × 1.000 ` 3.00.333 5.000 (260 × 1.7 Required: (i) Prepare Product Cost Statement under traditional absorption costing and Activity Based costing Method.000 Cost per Activity 6 3 Statement of Cost (Absorption) A Material Labour Overhead: Department I Department II Total cost ` 1.000 B (`) 8.20. of Activity 5.000 26.000 11.00.000 5.000 74.500 Statement of Cost as per ABC A (`) Material Labour Overhead: Receiving Set up cost Total cost 3.000 Question 3: The following information provides details of costs.000 ` 8.000 ` 26.000 (3 × 80.96.000 (2.00.00.000 (260 × 1.000 12.000) 14.20.00.00.80. of Activity 1.000 14.00.96.00.000 ` 9.000 (over) 5.00.94.00 Statement of Comparative Cost A Cost under Cost under traditional Absorption costing Difference 3.000 B 24. for product X.Activity Based Costing 5.000 × 280) 4.000 12.00.500) 14.000 Basis Labour hours Machine hours No.00.000 ` 15.000 15.000 Basis Requisition Set up No.00.000 Statement of Comparative Cost Actual Department I Department II 11.60.00. volume and cost drivers for a particular period in respect of ABC Ltd.800 × 280) 3.000 (6 × 80.00.000 23.83.000 15.000 (1.000) ` 2.00.000 × 3) 11.50.30.000 (40.500) 34.90.000 C (`) 9.36.500) 24.00.60.000 Total ` 22. Y and Z: Sec 1_Ch-05_Activity Based Costing.80.000 × 3) 39.04.000 5. Solution: Statement of Cost Pool (Absorption) Department I II Cost (`) 1.000 Effect 4.000) ` 630.10.00.000 8.30.000 (6 × 1.00.60.10.90. (ii) Compare the results under two methods.94.20.96.200 × 280) 3.000 (1.000 9.10.000 1.7 1/12/2011 3:51:58 PM .000 39.20.000 C 34.800 + 2.000 (30.000 ` 15.00.00.000 Total (`) 22.000 ` 9. indd 5. (b) Compute product costs using an activity based costing system. of deliveries No. 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.000 3.14. the company current costing system).40. Both the current and the previous cost system reported low profit margins for product X. In the past the company has allocated overheads to products on the basis of direct labour hours.e. of Production Runs No.000 8.00.000 ` 18.48.000 8.04. of production orders 30.000 Total Production and sale unit Raw material unit (usage) Direct material cost (`) Direct labour hour Machine hour Direct labour cost (`) No. the company past product costing system. which is the company’s highest-selling product.e.38. Solution: 1 (a) Statement of cost pool [Absorption] Overhead cost = ` 184.50.8000 Direct labour hours = 88.48.73.000 88.30.000 hrs (40000 + 40.000 Total (`) 12.000 2.000 5 20 2 1 12 7 3 35 10 Product Z 8.35.000 48.50.40. However the majority of overheads are related to machine hours rather than direct labour hours.40. of receipts ( 2 × 7) No.000 76. 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.000 (21 × 800) 3.8 Problems and Solutions: Advanced Management Accounting Product X Product Y 20.68.0000 Product Z (`) 88.000 (21 × 40.40.000 4.000) 18.000 5.48.5.000 The Company operates a just-in-time inventory policy and received each component once per production run.000 + 8000] Overhead cost per labour hours = 21 per hours Statement of Cost (Absorption) Particulars X (`) Material Labour Overhead Total 7.000 Y (`) 4.1/3 1 – 1/3 8 3 9 15 15 Overhead costs: Set-up Machines Receiving Packing Engineering 30.28.000 (21 × 40. 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.000 1.38.000 Sec 1_Ch-05_Activity Based Costing.000 7.000 2.000) 1. (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.000 36.000 2.60.).000 5 25 1.000 18.8 1/12/2011 3:51:59 PM .000 11 11 1 2 6 20 20 220 25 30 32 270 50 12. 40.00.28.72. of order No. of receipt No.000 4.57.59 Statement of Cost (Absorption) Material Labour Overhead: Receipts Others Cost X (`) 7. of receipt No.11 7.189 Z (`) 88.812.13. Details of the four products and relevant information are given below for one period: Product Output in units Costs per unit Direct material Direct labour Machine hours (per unit) A 240 ` 80 56 8 B 200 ` 100 42 6 C 160 ` 60 28 4 D 240 ` 120 42 6 The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units.000 2. The production overhead is currently absorbed by using a machine hour rate.600 10. Now.000 37. of receipt 14.000 3.884 Total (`) 12.000 48.600) 270 (15 + 35 + 220) 32 (9 + 3 + 20) 50 (15 + 10 + 25) Cost per Activity (`) 1000 10 1.000 2.000 17.000 no.000 5.000 4.000 30.35.01.840 Statement of Cost Pool (ABC) Overhead Setup Machine Receiving Packing Engineering Amount (`) 30.9 1 (b) Statement of Cost Pool (Absorption] Overhead Receipts Others Amount Basis 4.35.840 39.500 7.167 1.000 16.000 + 1.000 Question 4: G Ltd.73.50. use an activity based costing (ABC) system is being considered.35.460 Statement of Cost (ABC) Particulars Material Labour Overhead: Setup @ 1000 Machine @ 10 Receiving @ 1111.000 (40.000) Cost/Qty.500 10.380 Y (`) 4.000 20.389 7.000 24.14.611.000 + 16.000 3.40.000 7.1 18. 1. A conventional product costing system is used at present.000 2.000 (40.43.35.54.00.60.900 15.00.000 2.860 10. of set up Machine hour No.800 14.200 4.indd 5. produces four products.60.35. of Activity 30 (3 + 7 + 20) 76.87.000 + 20.5 7. and the total of the production overhead for the period has been analysed as follows: Particulars Machine department costs (Rent dep.426 Z (`) 88.9 1/12/2011 3:51:59 PM .611.54.000 4.28.240 52.000 5.000 Basis No.000 7.194 Total (`) 12.000 Sec 1_Ch-05_Activity Based Costing.767 Y (`) 4. and supervision) Set-up costs Stores receiving Inspection/quality control Output handling and dispatch Amount (`) 20.000 24.00.444 1.000 36.600 17.73.38.000 56.00.99.000 machine hours Quantity 270 (15 + 35 + 220] 76.86.97.28.167 7.13.11 Engineering @ 7460 Cost X (`) 7.444 2.Activity Based Costing 5.40.000 56.389 74.000 7.000 3.40.38.000 + 20.000 2.000 4.000 3.000 4.31.11.440 7.000 48.50.200 9. 200 4.440 (240 × 56) B (`) 20.240 A (`) 19.712 2.000 (8 × 250) 1.800 10.600 4. of order No.500 7.200 (1.200 Total (`) 77.500 7. Required: (a) to calculate the total costs for each product if all overhead costs are absorbed on a machine hour basis.000 Machine hours = 5.480 D (`) 28.66.699 (1.200 9.400 C (`) 9.01 250 90 100 110 No.800 800 1.303 20.200 13.000 (200 × 100) 8. Solution: Statement of Cost Pool Overhead Machine Setup cost Store Inspection Output handling and dispatch Amount 20.600 36.000 8.600 36.783 (1.920 + 1.440) Cost per machine hour = 10 Statement of Cost A (`) Material Labour Overhead @ 10 Cost 19.200 (1.400 7. (c) to calculate and list the unit product costs from your figures in (a) and (b) above. of requisition No.566 (640 × 4.006 5.920 + 1.920 × 4.480 6.860 1.080 (240 × 42) Total (`) 77.66.400 (640 × 10) 20.440 × 4.480 (160 × 28) D (`) 28.080 14.10 Problems and Solutions: Advanced Management Accounting The cost drivers to be used for the overhead costs are as listed below: Cost Cost Driver Set up costs Stores receiving Inspection/Quality control Output Number of production runs Requisitions raised Number of handling and dispatch production runs Orders executed The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 84.000 (1.01) 23.200 1.860 10.200 4.200 + 640 + 1.5.400 5. (b) to calculate the total costs for each product.440 × 10) 53.01) 40.800 (240 × 120) 10. of Activity 5.200 × 10 ) 40.812 (1.000 Statement of Cost Pool (Absorption) Overhead = ` 52.01) 48.640 10.800 1.240 Basis Machine hours No. of purchase order 42 (12 + 10 + 8 + 12) Statement of Cost (ABC) Cost Material Labour Overhead Setup Store Inspection Output handlings and dispatch Machine Total cost 3.500 (10 × 250) 1.indd 5.200 + 640 + 1.400 (200 × 42) C (`) 9.000 (12 × 250) 1.400 12. of set-up No. to show the differences and to comment briefly on any conclusions which may be drawn which could have pricing and profit implications.01) 53. using activity-based costing system.760 3.400 (1.440 19.920 × 10) 51.200 2.200 9.10 1/12/2011 3:51:59 PM . each order being for a batch of 10 of a product.640 2.800 1.800 1.200 2.000 2.200 (80 × 240) 13.000 Sec 1_Ch-05_Activity Based Costing.440) 42 (12 + 10 + 8 + 12) 80 (20 + 20 + 20 + 20) 84 (24 + 20 + 16 + 24) Cost per Activity 4.200 × 4.000 (12 × 250) 1.979 4.200 (1.200 2.840 B (`) 20.600 (160 × 60) 4. (The total value of overhead remains same).526 D 53. 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. Storage required is related to the average size of the basic incoming product units from each customer. There are three customers for whom the service is provided: John Ltd. Paul Ltd. The additional information for the year to 30 June has been estimated as follows: 1.400 312 C 23..000 25.11 1/12/2011 3:52:00 PM .66.840 (2. Labour and overhead costs have been identified as attributable to each of three work centers receipt and inspection.861) B 40.950 Note 1: Packaging materials are used in re-packing each cubic meter of product for John Ltd.11 Statement of Reconciliation A ABC (`) Absorption (`) Difference 48.979 51.66.000 45. Question 5: Repak Ltd is a warehousing and distribution stores the products and then re-packs them for distribution as required. Sec 1_Ch-05_Activity Based Costing. 30. George Ltd.Activity Based Costing 5.303 53.480 2. (ii) The product which consumes high volume of activity as compared to machine working hours will absorb high volume of overhead.280 23 Total 1.006 20.712 40. George Ltd and Paul Ltd in the ratio 1:2:3 respectively.000 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. 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. George Ltd and Paul Ltd. storage and packing as follows: Cost Allocation Proportions Receipts and inspection % Labour-basic Overtime Occupancy Administration and management 15 50 20 40 Storage % 10 15 60 10 Packing % 75 35 20 50 (iii) Studies have revealed that the fragility of different goods affects the receipts and inspection time needed for the products for each customer. The products from all three customers are similar in nature but of varying degrees of fragility. The re-packing of goods for each customers have been evaluated as follows (All Data are provided for each cubic meter for each customer).indd 5. This ratio is linked to the relative fragility of the goods for each customer.000 Costs ($000) Packing materials (see Note –1) Labour-Basic Overtime Occupancy Administration and management 350 30 500 60 1.000 1. 500 4.000 4.218 62.08.000 (1.3 45 Paul Ltd.4 × 30.00.000 1.69.500 (9.000 ` 9.3 36 Required: A: Calculate the budgeted average cost per cubic mater of packaged products for each customer for each of the following two circumstances: 1.219 29.2 60 Receipt and inspection (minutes) Storage (square meters) Packing (minutes) 5 0.500 Base 9.000 ⎠ George (`) 9.50.000 ` 4.000 George Ltd.30.63.500 Storage 35.30. George Ltd.500 × 9) + (2.000 9.000 + 25.77.000 30.40. 9 0.38.) 1. of Activity 1.23.000 4.000 Statement of Cost Pool (ABC) Activities Inspection Amount (`) 1.000 Basis Composite Ratio Quantity No.00. Where the additional information enables an activity-based costing Approach to be applied.000) [(5 × 30.270 10.000 83.950 (30:90:75 W.00.395 1.91.75.000) ` 98.82.500 × 15)] 27.5.03.35.000 + 20.000 (9.000 ` 2.00.073 94.50.45. 15 0.91.000 ` 7.00.000 ` 3.56 Paul (`) 7.4 Statement of Cost Quantity Packing material (30:90:75) Other cost Total Cost John Ltd.12 Problems and Solutions: Advanced Management Accounting John Ltd.50.475 17. 25.00.13.000) Cost per Activity 10.609 1.95 ⎛ 538475 ⎞ ⎜ ⎟ ⎝ 30.000 + 13.215 13.000 3.000 24.000 2.000 + 3.000 Raul Ltd.000 Statement of Cost (Additional Production) Packing Receiving & Inspection Storage Packing Total Cost/unit John 3.0000) Storage Packing 3.05.887 1.000 + 45.000 77. Department of Overhead Inspection Labour Overtime Occupancy Administration & management Total 52. 45. (ICWA Final 1988) Solution: Statement of Cost Pool (Basis budget) Cost Packing material Other Amount (`) 19.50.000 (9.000 + 4.000)] 46.000 ` 2.4 × 45.500 Packing 3.000) ` 13.23.00.03.500 3.56 ⎠ ⎛ 1021306 ⎞ ⎜ ⎟ ⎝ 25000 ⎠ Sec 1_Ch-05_Activity Based Costing.45.5.000 9.515 5.500 + 5.82. Where only the basic budget information is to be used.12 1/12/2011 3:52:00 PM .50.500 15.000 (1. 30.500 10.85 ⎛ 1330219 ⎞ ⎜ ⎟ ⎝ 29. 2.000) ` 5.05.00.000 30.N.000 + 1.000 1.4 × 25.indd 5.31.500 1.000 (9.21.306 40.25.000 (30.818 1.000 6.000) + (4. 000 100 52 24 10 5.000 960 48 36 30 15.Activity Based Costing 5.indd 5.500 2.000 units of a component K to be delivered in lots of 3. It uses a single overhead recovery rate based on direct labour hours.000 Q ` 4.13 1/12/2011 3:52:00 PM . The overheads incurred by the company in the first half of the year are as under: Particulars Machine operation expenses Machine maintenance expenses Salaries of technical staff Wages and Salaries of stores staff ` 10.000 • Direct wage rate ` 6 per hour • Production set-ups 2. • The technical staff salaries should be apportioned between machine maintenance. The job will involve as initial design cost of ` 60.500 1.000 90.000 30. set up and quality inspection in 30:40:30 ratio.12.000 units per quarter.13 Working Notes: John Ratio of packing material used Qty.62.000 and the manufacture will involve the following per quarter: Direct material costs Direct labour hours Production runs Inspection Number of consignment of direct materials to be received ` 12. It is also determined that: • The machine operation and machine maintenance expenses should be apportioned between stores and production activity in 20:80 ratio. the company-introduced activity based costing system and the following significant activities were identified: • Receiving materials and components • Set up of machines for production runs • Quality inspection. Relative composite material ratio Ratio: 1 30.500 During this period.960 • Number of quality inspections carried out 1.040 • Material and component consignments received from suppliers 1.37.87. The consumption of activities during the period under review are as under: • Direct labour hours worked 40.500 6. Sec 1_Ch-05_Activity Based Costing.280 The data relating to two products manufactured by the company during the period are as under: Particulars Direct material costs Direct labour hours Direct material consignment received Production runs Number of quality inspection done Quantity produced (units) Products P ` 6.000 75.000 George 2 45.000 Question 6: A company manufactures several products of varying levels of designs and models.000 300 6 24 20 The company desired a mark up of 25% on cost.000 A potential customser has approached the company for the supply of 24.000 30: 90: 75 Paul 3 25. 28 (275.A.250 Sec 1_Ch-05_Activity Based Costing.000 Labour hours = 40.000 (960 + 100 + ) Overhead/hour = 52.607 43.41 Statement of Cost for the Products P and Q P (`) Cost: Material Labour Overhead: Production Stores Inspection Total cost 24.623.000 + 11.035 14.000 Desige ⎛ x3000 ⎞ ⎜ ⎟ 24 ⎝ ⎠ Overhead: Store (275.78.250 + 2.55. of receipt Inspection No.55.000 1.000 Basis No.532.000 Quantity Inspection 30% 1. Final May 2003) SolutionL Statement of Cost Pool Overhead Stores Setup Amount ` 2.092 (670.494.U.960 (48 + 52 + …) 1.280 (30 + 10 +…) Cost per Activity 275. (670.89 × 48) 4.62.482.50 (iii) Statement of Cost and Selling Price per Quarter (ABC) Qty: 3000 (`) Material Labour 300 × 6 12.10 (149. Calculate the cost of product P and Q based on the existing system of single overhead recovery rate.13.91.38 6.89 × 20) Prod.128 34.14 Problems and Solutions: Advanced Management Accounting Required: 1.89 × 52) 1.5.242.250 Set-up 40% 2.14.346.760 (960 × 6) 4. of Activities 1.800 7500 Avoidable overhead 60.428 8.500 2. Compute the sales value per quarter of component K using activity based costing system.5 × 6) Quality inspection (149.000 5.3 (149.5 × 36) 13.02 16.indd 5.138 (670.41 × 24) Total cost Profit (25%) Sale value Selling Price P.41 × 10) 36. 3.41 × 300 53. Determine the cost of products P and Q using activity based costing system.00.89 149.72 (275.5 × 24) 14. 2. 13. (C.000 600 (100 × 6) Q (`) Statement of Cost Pool (Absorption) Overhead = ` 21.14 1/12/2011 3:52:01 PM .345 Working Notes Machine material 30% Salary of technical staff (637500) 19. 000 16.125 It can be distributed into store and production in the ratio of 20%: 80% i.250 + 10.000 51.38 Sec 1_Ch-05_Activity Based Costing.300 10.87. Product A is a standard product which is produced for one customer.440 3.000 6.B.800 Power 23.91. has been manufacturing and selling 4 products A.00 30. Products B and C are produced largely in response to orders received from a small number of customers.000 20.500 Total 1. Store = 2.400 1.500 B 800 30.250 Production = 11.indd 5.e.Activity Based Costing 5.00 17. Product D is produced in a range of different colors and is usually produced for stock with orders being dispatched from warehouse. The company is thinking of going to a new product line.500 47. but limited numbers are produced for inventory.500 1.500 Total 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.500 1. As all the operations are predominantly machine operation.78.600 21.000 D 500 35.20 The Cost Accountant of the company considering that using a blanket rate for common cost allocation will always be misleading.000 27. he finds that each product requires one half an hour of machine time.13.500 4.78 D 4.15 Machine mainte6nance and operation 1.500 Total Department Y C 1.60 D 7.500 ` Department X A 1.000 3.570 7.12. it may even discontinue one of the existing products after ascertaining the individual product costs and its profitability. the unit profit is worked out as: Particulars Profit per unit (`) Product A 0. according to the requirements of a long term contract.600 16.30 B 9.00 24. The following data collected pertain to a six months period: Product Units produced and sold Selling price (`) Sales revenue (`) Cost incurred (`) Direct material Direct labour 10.20 B 7.50 C 4.39.000 30.400 Warehouse & dispatch 19. In this process. Going into details the Cost Accountant makes a fresh calculation and arrives at the unit profitability of the products under: Particulars Profit per unit (`) Product A 2.650 hours–900 in X and 750 in Y. During the period the machines are used for 1.60 C 3.000 7.400 4.15 1/12/2011 3:52:01 PM .C and D — A & B in its production department X and C & D in its production department Y.000 Question 7: Change with Times Ltd.840 9.000 3. arriving at a machine hour rate for each department for allocating the common costs to the products.100 3.50 27.920 4.000 ` Factory Overhead Set up Supervision Machines Selling expenses Service department cost 1.370 Purchasing 2. as required. 5 60 4 200 200 400 With the help of these figures.5 20 2 100 50 200 D 25 4 50 0. (c) activity based costing as suggested by the Management Accountant.5.) Orders processed per period Raw materials inputs per unit Average holding of finished goods (unit) No.370 2. (ICWA Final Dec. he collects the following details: Activity Cost-pools Set up Supervision Machines Order processing Material handling Finished goods storage Dispatch Power Selling expenses Amount (`) 1.16 1/12/2011 3:52:01 PM .16 Problems and Solutions: Advanced Management Accounting His calculation is based on the following details: Allocation of Common Costs (`) Factory Overheads Set up Supervision Machines Service Department Cost Purchasing Warehouse and dispatch Power plant 4.000 The Management Accountant who has joined the company recently is not at all satisfied with the Cost Accountant’s calculation. He feels that an important decision to drop a product cannot be taken based on those figures. why not do an activity based costing: With this end in view.indd 5.200 9. 1994) Sec 1_Ch-05_Activity Based Costing.5 20 5 100 40 160 C 100 1 75 0.100 on units produced 3.5 10 2 0 10 30 B 50 2 40 0.400 19.200 10.370 2.) Machine timer per unit (hrs. he makes that allocation activity based and produces a profit statement for submission to management.000 1.600 1.300 on hours of usage of machines Total 1. Required: Prepare the product profitability statement based on – (a) the blanket rate.800 Y 900 1.) Supervisor’s time per period (hrs.440 to be allocated on material costs 3.500 3.5 75 0.800 440 4. of deliveries per period Sales staff time per period (hrs. He is of the view that a more refined technique is required and when details are available.800 X 470 1.) A 100 1.400 19.300 7.920 Cost Drivers Particulars Production batch size (units) Set up time (hrs. (b) the machine hour rate as the Cost Accountant has done. 000 3.000 D (`) 7.000 3.500 16.600 6.4 Sec 1_Ch-05_Activity Based Costing.600 C (`) 9.19) 10. of Activity 137 (15 + 32 + 10 + 80) 240 (75 + 40 + 75 + 50) 1.900 8.200 10.75 2 10.410 1.410 7.400 19.200 1.003 2.500 1.Activity Based Costing 5.000 (200 + 4000 + 2.830 99.440 3.400 26.310 17.203 27.000 12.000 3.500 2.598 Total (`) 32.200 9.003 2.000 15.000 7678 C (`) 9.004 10.800 18.648) 2.400 1.650 (500 + 400 + 500 + 250) 790 (30 + 160 + 200 + 400) 3.800 1.400 1.000 1.500 1. Statement of Cost Pool Overhead Set up Supervision Machine Ordering price Material handling Finished goods Dispatch Poser Selling expenses Amount 13.236 780 21.indd 5. Statement of Profit (Machine Hour Base) A (`) Material Labour Overhead Setup Total cost Selling price Profit 25.902 17.920 Set-up Supervision Hr Machine hour Order Raw mat.410 (250 × 21.691 2.500 2.800 3.200 27.70 2.370 2.85 3.000 5.295 27.650 20.648) 2.500 3.000) 400 (0 + 100 + 100 + 200) 4 400 (10 + 40 + 50 + 200) 1.170 Note: Under recovery and over recovery exist only when actual base is different from budgeted base.500 297 B (`) 6.650 (500 + 400 + 500 + 250) 110 (10 + 20 + 20 + 60) 10.227 1. 2.076 (400 × 20.205 17.500 3.17 1/12/2011 3:52:01 PM .996 24.920 25.000 4.095 (500 × 20.400 19.820 (500 × 21.402 1.17 Solution: 1.000 10.920 16.600 1.100 4. input Av.000 + 2.920 83.000 3. Rate 470 1.800 440 4.403 30.409 2.300 7.000 3597 D (`) 7.220 30.322 24.400 1.400 15.600 34.64 Total 1.400 13. Statement of Profit (Absorption) A (`) Material Direct labour Factory overhead (34410) Selling expenses Total cost Selling price Profit 10.190 8.19 Y 900 1.174 900 20.000 4.000 12.19) B (`) 6. holding Delivery Machine hrs Sale staff Basis No.300 34.000 6.0253 ` 10 10 10 4 0.002 1.780 Statement of Machine Hours X Setup Supervision Machines Warehouse Purchasing Power plant Total Machine hrs.000 1.213 1. 75 × 40) 800 1.75 × 200) 500 4.000 6.76 (30 × 10.25 4 3.000 300.600 9. conversion (70%).154 24500 5.0253) 22.0253 × 200) 23. Packing material (30%) Sec 1_Ch-05_Activity Based Costing.000 × .677. Fixed Costs will remain unchanged throughout a wide activity range.005 (10. Required: (a) Using the above information.078.800 (400 × 12) 80 (4 × 20) 1.5.010. trimming (40%) Packing Process.4) (0 × 4) 37.5 30.000 (500 × 12) 40 (4 × 10) 800 (2. make and sell two products.0253 × 160) 18. Calculate unit costs for each product.4) 400 (4 × 100) 187.24) Question 8: The Excel Ltd.000 (500 + 12) 80 (4 × 20) 800 (2000 × 0. the remainder are company fixed costs.V4 and V2.400 1.421.0253 × 400) 19.000 180 30 V4 V2 (iii) Conversion costs are absorbed by products using estimated time based rates.000 3. analysed as relevant.500 1. (c) Additional information is gathered for the period ending 31 March has follows: (i) The proportion of product specific conversion costs (variable and fixed) are analysed as follows: Making Process: moulding (60%).26 27500 5.25 6 5.5 (3.600 (4000 × . Statement of Profit (ABC) A (`) B (`) 6.18 1/12/2011 3:52:02 PM .75 × 10) 1.400.5 800 (80 × 10) 500 (50 × 10) 3.846 100 (10 × 10) 750 (75 × 10) 6.000 150 30 5.24 17500 (2. The following estimated information is available for the period ending 31 March.18 Problems and Solutions: Advanced Management Accounting 4.5 (3.000 (250 × 12) 240 (4 × 60) 800 (2000 × 0.900.000 C (`) 7.000 2.604 (10. Making Conversion cost Variable Fixed ($000) 350 210 Packing ($000) 280 140 40% of fixed costs are product specific.indd 5.000 D (`) Material Labour Overhead: Setup Supervision Machine Ordering price Material handling Finished Dispatch Power Selling Total cost Sale value Profit 10.000 150 (15 × 10) 750 (750 × 10) 6.75 × 50) 1.4) 400 (4 × 100) 150 (3. Product information Production time per unit Making (minutes) Packing (minutes) Production sales (units) Selling price per unit($) Direct material per unit (S) 5.24 (10.74 320 (32 × 10) 400 (40 × 10) 4.4) 800 (4 × 200) 750 (3. (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.000 3. Both products are manufactures through two consecutive process-making and packing raw materials is input at the commencement of the making process.322. 33 Statement of Cost and Revenue V4 (`) Material cost Conversion cost: (i) Making. Packing materials (which are part of the variable packing cost) requirements depends on the complexity of packing specified for each product.000) 24.26.000 42.25 × 3000)] 42.20.000.000 Total (`) 2.000 (30.000 56.indd 5.61.e.000) 6.750) (2 × 12.00.50.25) 52. Required: Calculate amended unit costs for each product where activity based costing is used and company fixed costs are apportioned as detailed above.19 1/12/2011 3:52:02 PM .60 × 12. The variable and Product fixed packing process conversion cost are incurred in proportion to the time required for each product.000 Time minute 84.750 (8. we can say that such fixed cost can be termed as fixed cost.000 12.750 (26.3 × 5.80.750 78.000 Time 56.000 × 5.The moulding variable and product fixed cost conversion costs are incurred in proportion to the temperate required in the moulds.000 Time No.250 (3 × 15.3 × 15.000 1.000 Time 28. i.31.000 1.000 [(5.000 2.000 88.500 (2 × 26.26.48.250 (8.38.750 + 60.000 70.000 Decision: It is not advisable to discontinue the product V4 because unavoidable fixed cost 78.250) 40.000 1.000 (6. of Activity 42.000 42.80.000 42.18.750 remains constant.Activity Based Costing 5.000 2.000 Time 84.250× 3) (2 × 30.40.000 10.3) 6.91.000 V2 (`) 90.000 × 1. 1.90. Solution: Statement of Cost Pool Conversion Making: Variable Avoid: Fixed cost Unavoidable overhead Packing: Variable Fixed unavoidable Fixed avoidable $ Basis 3.66 2 1.000 Time 1.50.40.000 Cost per Activity 8.000 2.000) 16.10.25 × 5000) + 5.000 × 1.50.250 47.33 2 3 6.000 (12.19 (ii) The making process consist of two consecutive activities. Hence.750) 80. (iii) An investigation into the effect of the cost drivers on costs has indicated that the proportions in which the total product specific conversion costs are related to V4 and V2 are as follows: Temperature (moulding) Material consistency (trimming) Time (packing) Packing (complexity) V4 2 2 3 1 V2 1 5 2 3 (iv) Company fixed costs is apportioned to product at an overall average rate per product unit based on the estimated figures.750 5.000 1.000 3.000 50. The trimming conversion variable and product fixed costs are incurred in proportion to the consistency of the material. Sec 1_Ch-05_Activity Based Costing.3) 3. Variable cost Avoidable fixed cost Fixed cost Relevant cost Sale Benefit Unavoidable fixed cost: Packing Making Profit 1.000 84.250 7.000 42.50. mounding and trimming.