Activity Based Costing

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.

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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 rst tracing costs to activities and then tracing costs from activities to products. Denitions of Important Terms Cost 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. 2. 3. 4. 5. 6. Identify, dene, and classify activities and key attributes. Assign the cost of resources to activities. Assign the cost of secondary activities to primary activities. Identify cost objects and specify the amount of each activity consumed by specic cost objects. Calculate primary activity rate. Assign activity costs to cost objects.

Classifying Activities To help identify activity driver and enhance the management of activities, activities are often classied 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. (ii) There is a great diversity in the product range. (iii) Product use very different amounts of overhead resources. (iv) Overheads are signicantly non unit level overheads. 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. (ii) For identication 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 specication 3. Activity denition 4. Activity driver selection 5. Costing

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Activity Based Costing 5.3 Activity Based Cost Management Activity based cost management is a system wide, integrated approach that focuses managements attention on activities with the objective of improving customer value and prot achieved by providing this value. ABC is the major source of information for activity based management.
ABM Model

Systems Planning

Identify, Define, 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, 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.

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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. Statement of Cost (ABC Technique) Product Material (identied) Labour (identied) Overhead Set up Cost COST POOL Overheads Machine Rent Setup Cost Stores Inspection Cost Packing Charges Others Amount Rs. XX XX XX XX XX XX XX XX Activity No. of times Usage No. of Setup/Setup hour No. of Required Slip/Material Cost/Qty. No. of Set up Production Rent No. of livery Method of absorption No. 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. Non activity oriented overheads so that all the overheads called be identied 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 identied with the product. Direct Material: 1: Directing traced with production 2: Final quantity increase. 3: Integral and major part. Indirect material: Used to produced nished Good with raw material.

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Activity Based Costing 5.5

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. Measures of activity performance are both nancial and non nancial and center on three major dimensions: (a) efciency, (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 efciency. 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.
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 A B C D Volume 500 5,000 6,00 7,000 Material cost per unit $5 $5 $16 $17 Direct labour per unit hour hour 2 hour 2 hours Machine time per unit hour hour 1 hour 1 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 $ 37,749. 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 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. To compute an overhead coproduct using activity-based costing, tracing overheads to production units by means of cost drivers. 2. To comment briey on the differences disclosed between overheads traced by the present system and those traced by activity based costing.

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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 (`) 4,250 1,920 7,560 8,400 37,749 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 57.77 700 3.0259

Statement of Cost Sheet

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

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

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

Production overhead split by departments

Department 1 = ` 11,00,000 Department 2 = ` 15,00,000 Department 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

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Activity Based Costing 5.7

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

Statement of Cost (Absorption)

A Material Labour Overhead: Department I Department II Total cost ` 1,80,000 (30,000 6) ` 1,20,000 (40,000 3) 11,00,000 ` 4,80,000 (6 80,000) ` 2,40,000 (3 80,000) 23,20,000 ` 9,00,000 (6 1,50,000) ` 630,000 (2,10,000 3) 39,30,000 ` 15,60,000 ` 9,90,000 73,50,000 ` 5,00,000 ` 3,00,000 B ` 8,00,000 ` 8,00,000 C ` 9,00,000 ` 15,00,000 Total ` 22,00,000 ` 26,00,000

Statement of Comparative Cost

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

Statement of Cost Pool [ABC]

Overhead Receiving and inspection Setup Amount (`) 14,00,000 12,00,000 Basis Requisition Set up No. of Activity 5,000 [1,200 + 1,800 + 2,000] 800 [240 + 260 + 300] Cost per Activity 280 1,500

Statement of Cost as per ABC

A (`) Material Labour Overhead: Receiving Set up cost Total cost 3,36,000 (1,200 280) 3,60,000 (240 1,500) 14,96,000 5,04,000 (1,800 280) 3,90,000 (260 1,500) 24,94,000 5,60,000 (2,000 280) 4,50,000 (260 1,500) 34,10,000 14,00,000 12,00,000 74,00,000 5,00,000 3,00,000 B (`) 8,00,000 8,00,000 C (`) 9,00,000 15,00,000 Total (`) 22,00,000 26,00,00

Statement of Comparative Cost

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

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:

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Problems and Solutions: Advanced Management Accounting

Product X Product Y 20,000 5 20 2 1 12 7 3 35 10 Product Z 8,000 11 11 1 2 6 20 20 220 25 30 32 270 50 12,38,000 88,000 76,000 Total

Production and sale unit Raw material unit (usage) Direct material cost (`) Direct labour hour Machine hour Direct labour cost (`) No. of Production Runs No. of deliveries No. of receipts ( 2 7) No. of production orders

30,000 5 25 1- 1/3 1 1/3 8 3 9 15 15

Overhead costs: Set-up Machines Receiving Packing Engineering

30,000 7,60,000 4,35,000 2,50,000 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 prot margins for product X, which is the companys 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 X (`) Material Labour Overhead Total 7,50,000 2,40,000 8,40,000 (21 40,000) 18,30,000 Y (`) 4,00,000 2,40,000 8,40,000 (21 40,000) 1,48,0000 Product Z (`) 88,000 48,000 1,68,000 (21 800) 3,04,000 Total (`) 12,38,000 5,28,000 18,48,000 36,14,000

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Activity Based Costing 5.9 1 (b) Statement of Cost Pool (Absorption]

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

Statement of Cost (Absorption)

Material Labour Overhead: Receipts Others Cost X (`) 7,50,000 2,40,000 24,167 7,43,600 17,57,767 Y (`) 4,00,000 2,40,000 56,389 7,31,800 14,28,189 Z (`) 88,000 48,000 3,54,444 2,97,440 7,87,884 Total (`) 12,38,000 5,28,000 4,35,000 17,72,840 39,73,840

Statement of Cost Pool (ABC)

Overhead Setup Machine Receiving Packing Engineering Amount (`) 30,000 7,60,000 4,35,000 4,35,000 3,73,000 Basis No. of set up Machine hour No. of receipt No. of receipt No. of order No. of Activity 30 (3 + 7 + 20) 76,000 (40,000 + 20,000 + 1,600) 270 (15 + 35 + 220) 32 (9 + 3 + 20) 50 (15 + 10 + 25) Cost per Activity (`) 1000 10 1,611.11 7,812.5 7,460

Statement of Cost (ABC)

Particulars Material Labour Overhead: Setup @ 1000 Machine @ 10 Receiving @ 1111.11 Engineering @ 7460 Cost X (`) 7,50,000 2,40,000 3,000 4,00,000 24,167 1,11,900 15,99,380 Y (`) 4,00,000 2,40,000 7,000 2,00,000 56,389 74,600 10,01,426 Z (`) 88,000 48,000 20,000 16,00,000 3,54,444 1,86,500 10,13,194 Total (`) 12,38,000 5,28,000 30,000 7,60,000 4,35,000 37,000 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 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. 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 Machine department costs (Rent dep. and supervision) Set-up costs Stores receiving Inspection/quality control Output handling and dispatch Amount (`) 20,860 10,500 7,200 4,200 9,240 52,000

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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, 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 gures in (a) and (b) above, to show the differences and to comment briey on any conclusions which may be drawn which could have pricing and prot implications.
Solution:

Statement of Cost Pool

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

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 3,000 (12 250) 1,800 1,200 2,640 2,500 (10 250) 1,800 1,000 2,200 2,000 (8 250) 1,800 800 1,760 3,000 (12 250) 1,800 1,200 2,640 10,500 7,200 4,200 9,240 A (`) 19,200 (80 240) 13,440 (240 56) B (`) 20,000 (200 100) 8,400 (200 42) C (`) 9,600 (160 60) 4,480 (160 28) D (`) 28,800 (240 120) 10,080 (240 42) Total (`) 77,600 36,400

7,699 (1,920 4.01) 48,979

4,812 (1,200 4.01) 40,712

2,566 (640 4.01) 23,006

5,783 (1,440 4.01) 53,303

20,860 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 Cost
A (`) Material Labour Overhead @ 10 Cost 19,200 13,440 19,200 (1,920 10) 51,840 B (`) 20,000 8,400 12,000 (1,200 10 ) 40,400 C (`) 9,600 4,480 6,400 (640 10) 20,480 D (`) 28,800 10,080 14,400 (1,440 10) 53,200 Total (`) 77,600 36,400 5,200 1,66,000

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Activity Based Costing 5.11 Statement of Reconciliation

A ABC (`) Absorption (`) Difference 48,979 51,840 (2,861) B 40,712 40,400 312 C 23,006 20,480 2,526 D 53,303 53,280 23 Total 1,66,000 1,66,000 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. (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. George Ltd. Paul Ltd. 30,000 45,000 25,000 Costs ($000) Packing materials (see Note 1) Labour-Basic Overtime Occupancy Administration and management 350 30 500 60 1,950

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 identied as attributable to each of three work centers receipt and inspection, 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. 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).

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5.12

Problems and Solutions: Advanced Management Accounting

John Ltd. George Ltd. 9 0.3 45 Paul Ltd. 15 0.2 60

Receipt and inspection (minutes) Storage (square meters) Packing (minutes)

5 0.3 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. 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 Packing material Other Amount (`) 19,50,000 9,40,000 Basis Composite Ratio Quantity No. of Activity 1,950 (30:90:75 W.N.) 1,00,000 (30,000 + 45,000 + 25,000) Cost per Activity 10,000 9.4

Statement of Cost
Quantity Packing material (30:90:75) Other cost Total Cost John Ltd. 30,000 ` 3,00,000 ` 2,82,000 (9.4 30,000) ` 5,82,000 George Ltd. 45,000 ` 9,00,000 ` 4,23,000 (9.4 45,000) ` 13,23,000 Raul Ltd. 25,000 ` 7,50,000 ` 2,35,000 (9.4 25,000) ` 98,5,000

2. Department of Overhead
Inspection Labour Overtime Occupancy Administration & management Total 52,500 15,000 1,00,000 24,000 1,91,500 Storage 35,000 4,500 3,00,000 6,000 3,45,500 Packing 3,63,500 10,500 1,00,000 30,000 4,03,000

Statement of Cost Pool (ABC)

Activities Inspection Amount (`) 1,91,500 Base 9,30,000 (1,50,000 + 4,05,000 + 3,75,000) [(5 30,000) + (4,500 9) + (2,500 15)] 27,500 (9,000 + 13,500 + 5,000)] 46,05,000 (1,08,000 + 20,25,000 + 1,50,0000)

Storage Packing

3,45,500 4,03,000

Statement of Cost (Additional Production)

Packing Receiving & Inspection Storage Packing Total Cost/unit John 3,00,000 30,887 1,13,073 94,515 5,38,475 17.95 538475 30,000 George (`) 9,00,000 83,395 1,69,609 1,77,215 13,30,219 29.56 Paul (`) 7,50,000 77,218 62,818 1,31,270 10,21,306 40.85

1330219 29.56

1021306 25000

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Activity Based Costing 5.13 Working Notes:

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

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 rst half of the year are as under:
Particulars Machine operation expenses Machine maintenance expenses Salaries of technical staff Wages and Salaries of stores staff ` 10,12,500 1,87,500 6,37,500 2,62,500

During this period, the company-introduced activity based costing system and the following signicant activities were identied: 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 production 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:
Particulars Direct material costs Direct labour hours Direct material consignment received Production runs Number of quality inspection done Quantity produced (units) Products P ` 6,000 960 48 36 30 15,000 Q ` 4,000 100 52 24 10 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 Direct labour hours Production runs Inspection Number of consignment of direct materials to be received ` 12,000 300 6 24 20

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

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5.14

Problems and Solutions: Advanced Management Accounting

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 Pool

Overhead Stores Setup Amount ` 2,78,250 + 2,62,500 2,55,000 + 11,13,000 Basis No. of receipt Inspection No. of Activities 1,960 (48 + 52 + ) 1,280 (30 + 10 +) Cost per Activity 275.89 149.41

Statement of Cost for the Products P and Q

P (`) Cost: Material Labour Overhead: Production Stores Inspection Total cost 24,138 (670.5 36) 13,242.72 (275.89 48) 4,482.3 (149.41 300 53,623.02 16,092 (670.5 24) 14,346.28 (275.89 52) 1,494.10 (149.41 10) 36,532.38 6,000 5,760 (960 6) 4,000 600 (100 6) Q (`)

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 Labour 300 6 12,000 1,800 7500

Avoidable overhead 60,000 Desige x3000 24

Overhead: Store (275.89 20) Prod. (670.5 6) Quality inspection (149.41 24) Total cost Prot (25%) Sale value Selling Price P.U.

13,128 34,428 8,607 43,035 14.345

Working Notes
Machine material 30% Salary of technical staff (637500) 19,14,250 Set-up 40% 2,55,000 Quantity Inspection 30% 1,91,250

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Activity Based Costing 5.15 Machine mainte6nance and operation 1,91,250 + 10,12,500 1,87,500 Total 1,39,125 It can be distributed into store and production in the ratio of 20%: 80% i.e. Store = 2,78,250 Production = 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 protability. 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 10,000 3,000 6,400 1,600 16,400 4,600 21,000 ` Factory Overhead Set up Supervision Machines Selling expenses Service department cost 1,370 Purchasing 2,400 Warehouse & dispatch 19,800 Power 23,570 7,920 4,440 3,100 3,300 10,840 9,000 3,000 7,500 1,000 16,500 4,000 20,500 ` Department X A 1,000 27.50 27,500 B 800 30.00 24,000 51,500 Total Department Y C 1,000 30.00 30,000 D 500 35.00 17,500 47,500 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, the unit prot is worked out as:
Particulars Prot per unit (`) Product A 0.30 B 9.60 C 3.60 D 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 nds that each product requires one half an hour of machine time. During the period the machines are used for 1,650 hours900 in X and 750 in Y. Going into details the Cost Accountant makes a fresh calculation and arrives at the unit protability of the products under:
Particulars Prot per unit (`) Product A 2.20 B 7.50 C 4.78 D 4.38

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5.16

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 4,440 to be allocated on material costs 3,100 on units produced 3,300 on hours of usage of machines Total 1,370 2,400 19,800 X 470 1,200 10,800 Y 900 1,200 9,000

The Management Accountant who has joined the company recently is not at all satised with the Cost Accountants calculation. He feels that an important decision to drop a product cannot be taken based on those gures. He is of the view that a more rened 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 Set up Supervision Machines Order processing Material handling Finished goods storage Dispatch Power Selling expenses Amount (`) 1,370 2,400 19,800 440 4,000 1,600 1,500 3,300 7,920

Cost Drivers
Particulars Production batch size (units) Set up time (hrs.) Supervisors time per period (hrs.) Machine timer per unit (hrs.) Orders processed per period Raw materials inputs per unit Average holding of nished goods (unit) No. of deliveries per period Sales staff time per period (hrs.) A 100 1.5 75 0.5 10 2 0 10 30 B 50 2 40 0.5 20 5 100 40 160 C 100 1 75 0.5 20 2 100 50 200 D 25 4 50 0.5 60 4 200 200 400

With the help of these gures, he makes that allocation activity based and produces a prot statement for submission to management.
Required: Prepare the product protability 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)

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Activity Based Costing 5.17

Solution:

1. Statement of Prot (Absorption)

A (`) Material Direct labour Factory overhead (34410) Selling expenses Total cost Selling price Prot 10,000 3,000 12,003 2,200 27,203 27,500 297 B (`) 6,400 1,600 6,402 1,920 16,322 24,000 7678 C (`) 9,000 3,000 12,003 2,400 26,403 30,000 3597 D (`) 7,500 1,000 4,002 1,400 13,902 17,500 3,598 Total (`) 32,900 8,600 34,410 7,920 83,830 99,000 15,170

Note: Under recovery and over recovery exist only when actual base is different from budgeted base. 2. Statement of Prot (Machine Hour Base)
A (`) Material Labour Overhead Setup Total cost Selling price Prot 25,295 27,500 2,205 17,996 24,000 6,004 10,000 3,000 10,095 (500 20.19) B (`) 6,400 1,600 C (`) 9,000 3,000 D (`) 7,500 1,000 5,410 (250 21.648) 2,400 1,400 15,310 17,500 2,190

8,076 (400 20.19) 10,820 (500 21.648) 2,200 1,920 25,220 30,000 4,780

Statement of Machine Hours

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

3. Statement of Cost Pool

Overhead Set up Supervision Machine Ordering price Material handling Finished goods Dispatch Poser Selling expenses Amount 13.70 2,400 19,800 440 4,000 1,600 1,500 3,300 7,920 Set-up Supervision Hr Machine hour Order Raw mat. input Av. holding Delivery Machine hrs Sale staff Basis No. of Activity 137 (15 + 32 + 10 + 80) 240 (75 + 40 + 75 + 50) 1,650 (500 + 400 + 500 + 250) 110 (10 + 20 + 20 + 60) 10,000 (200 + 4000 + 2,000 + 2,000) 400 (0 + 100 + 100 + 200) 4 400 (10 + 40 + 50 + 200) 1,650 (500 + 400 + 500 + 250) 790 (30 + 160 + 200 + 400) 3.75 2 10.0253 ` 10 10 10 4 0.4

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5.18

Problems and Solutions: Advanced Management Accounting 4. Statement of Prot (ABC)

A (`) B (`) 6,400 1,600 9,000 3,000 C (`) 7,500 1,000 D (`)

Material Labour Overhead: Setup Supervision Machine Ordering price Material handling Finished Dispatch Power Selling Total cost Sale value Prot

10,000 3,000

150 (15 10) 750 (750 10) 6,000 (500 12) 40 (4 10) 800 (2,000 .4) (0 4) 37.5 (3.75 10) 1,000 300.76 (30 10.0253) 22,078.26 27500 5,421.74

320 (32 10) 400 (40 10) 4,800 (400 12) 80 (4 20) 1,600 (4000 .4) 400 (4 100) 150 (3.75 40) 800 1,604 (10.0253 160) 18,154 24500 5,846

100 (10 10) 750 (75 10) 6,000 (500 + 12) 80 (4 20) 800 (2000 0.4) 400 (4 100) 187.5 (3.75 50) 1,000 2,005 (10.0253 200) 23,322.5 30,000 6,677.5

800 (80 10) 500 (50 10) 3,000 (250 12) 240 (4 60) 800 (2000 0.4) 800 (4 200) 750 (3.75 200) 500 4,010.24 (10.0253 400) 19,900.24 17500 (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 Conversion cost Variable Fixed ($000) 350 210 Packing ($000) 280 140

40% of xed costs are product specic, the remainder are company xed costs. Fixed Costs will remain unchanged throughout a wide activity range.
Product information Production time per unit Making (minutes) Packing (minutes) Production sales (units) Selling price per unit($) Direct material per unit (S) 5.25 6 5,000 150 30 5.25 4 3,000 180 30 V4 V2

(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 specic conversion costs (variable and xed) are analysed as follows: Making Process: moulding (60%); trimming (40%) Packing Process; conversion (70%), Packing material (30%)

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Activity Based Costing 5.19 (ii) The making process consist of two consecutive activities, mounding and trimming.The moulding variable and product xed cost conversion costs are incurred in proportion to the temperate required in the moulds. The trimming conversion variable and product xed costs are incurred in proportion to the consistency of the material. The variable and Product 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 specied 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 specic 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 xed costs is apportioned to product at an overall average rate per product unit based on the estimated gures.
Required: Calculate amended unit costs for each product where activity based costing is used and company xed

costs are apportioned as detailed above.

Solution:

Statement of Cost Pool

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

Statement of Cost and Revenue

V4 (`) Material cost Conversion cost: (i) Making; Variable cost Avoidable xed cost Fixed cost Relevant cost Sale Benet Unavoidable xed cost: Packing Making Prot 1,50,000 V2 (`) 90,000 Total (`) 2,40,000

2,18,750 (8.3 5,000 5.25) 52,500 (2 26,250) 40,000 (30,000 1.3) 6,61,250 7,50,000 88,750 78,750 (26,250 3) (2 30,000) 6,00,000 50,000

1,31,250 (8.3 15,750) 80,000 (6.60 12,000) 16,000 (12,000 1.3) 3,48,750 5,40,000 1,91,250 47,250 (3 15,750) (2 12,000) 24,000 1,20,000

3,50,000 2,80,000 56,000 10,10,000 12,90,000 2,80,000 1,26,000 84,000 70,000

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

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