Case Study in Activity Based Management

Dilbert Laboratories Limited

Facts of the case

The company manufactures three (3) products AA, BB, and CC.
In the past, the company had allocated company overhead using predetermined rates as follows:
Production Costs: Based on direct labour costs.
Selling and Administrative Costs: Based on number of units.

The management accountant has decided to use an activity based costing system to allocate overheads in the coming year.

Activities Identified Cost Type Cost Driver

Sales order processing Selling and Admin No. of Orders
Materials purchasing Production No. of Purchase Orders
Inventory Management Production No. of Parts per Unit
Machine Set-Up Production Set-Up Hours
Other Production Overhead Production Machine Hours
Packing and Delivery Selling and Admin No. of Deliveries
Total

BUDGET

Products AA BB
Budgeted Units 100,000 50,000

Budgeted Driver Units

No. of Sales Orders per product 20 50
No. of Purchase Orders per product 30 20
No. of Parts per Unit 6 8
Set-Up Hours per Product 50 80
Machine Hours per Unit 6 8
No. of Deliveries per product 20 60

Budget Direct costs per Unit

Direct Materials 5 8
Direct Labour 3 4
Selling Price per Unit 15 25

ACTUAL

Products AA BB
Actual Production 100,000 50,000

Actual Driver Units

No. of Sales Orders per product 20 50
No. of Purchase Orders per product 30 20
No. of Parts per Unit 6 8
Set-Up Hours per Product 50 80
Machine Hours per Unit 6 8
No. of Deliveries per product 20 60

Activities Identified Cost Driver Actual Overhead

Sales order processing No. of Orders 50,000
Materials purchasing No. of Purchase Orders 90,000
 Inventory Management No. of Parts per Unit 200,000
Machine Set-Up Set-Up Hours 120,000
Other Production Overhead Machine Hours 200,000
Packing and Delivery No. of Deliveries 170,000

Activities Identified Cost Driver Actual Overhead

Production Costs Direct Labor Costs 610,000
Selling and Administration No. of Units 220,000

Actual Direct Costs per Unit

Direct Materials 5 8
Direct Labour 3 4
Selling Price per Unit 15 25

REQUIREMENTS

1 Activities Identified Cost Driver Budgeted Overhead

Sales order processing No. of Orders 50,000
Materials purchasing No. of Purchase Orders 100,000
Inventory Management No. of Parts per Unit 200,000
Machine Set-Up Set-Up Hours 120,000
Other Production Overhead Machine Hours 200,000
Packing and Delivery No. of Deliveries 170,000

2 Activities Identified Cost Driver Budgeted Overhead

Production Costs Direct Labor Costs 620,000
Selling and Administration No. of Units 220,000

AA BB
Budgeted Cost per Unit
Direct Materials 5 8
Direct Labour 3 4
Overhead Allocated 5 6
Total 13 18

Budgeted Gross Profit Margin

Revenues 15 25
Cost of Sales 13 18
Gross Profit 2 7
Gross Profit Margin 15% 29%

3 Activities Identified AA BB
Sales order processing 2,703 6,757
Materials purchasing 37,500 25,000
Inventory Management 41,379 55,172
Machine Set-Up 21,429 34,286
Other Production Overhead 46,154 61,538
Packing and Delivery 8,947 26,842
Total 158,112 209,595
Budgeted Units 100,000 50,000
Budgeted Overhead per Unit 2 4

AA BB
Budgeted Cost per Unit
Direct Materials 5 8
 Direct Labour 3 4
Overhead Allocated 2 4
Total 10 16

Budgeted Gross Profit Margin

Revenues 15 25
Cost of Sales 10 16
Gross Profit 5 9
Gross Profit Margin 36% 35%

4 OLD

AA BB
Actual Production x Actual Rates 323,322 215,548
Actual Production x Budgeted Rates 332,143 221,429
Budgeted Production x Budgeted Rate 332,143 221,429

It cannot be inferred right away if the the purchasing department performed efficiently because the cost was grouped together with othe

NEW

AA BB
Actual Production x Actual Rates 38,571 25,714
Actual Production x Budgeted Rates 37,500 25,000
Budgeted Production x Budgeted Rate 37,500 25,000

It is apparent in this analysis that the purchasing department may have an unfavorable overhead spend but has overall performed efficie
Budgeted Overhead Actual Overhead
50,000 50,000
100,000 90,000
200,000 200,000
120,000 120,000
200,000 200,000
170,000 170,000
840,000

CC Total
10,000 160,000

300 370
30 80
15 29
150 280
12 26
300 380

15
6
60

CC Total
11,000 161,000

300 370
20 70
15 29
150 280
12 26
300 380

Actual Units Cost per Diver Unit

370 135
70 1,286
 29 6,897
280 429
26 7,692
380 447

Budgeted Units Cost per Diver Unit

566,000 1.08
161,000 1.37

15
6
57

Budgeted Units Cost per Diver Unit

370 135
80 1,250
29 6,897
280 429
26 7,692
380 447

Budgeted Units Cost per Diver Unit

560,000 1.11
160,000 1.38

CC

15
6
8
29

60
29
31
52%

CC Total
40,541 50,000
37,500 100,000
103,448 200,000
64,286 120,000
92,308 200,000
134,211 170,000
472,293 840,000
10,000
47

CC

15
 6
47
68

60
68
(8)
-14%

CC Total
71,131 610,000
73,071 626,643 (16,643) favorable overhead spending variance
66,429 620,000 6,643 unfavorable overhead efficiency variance

was grouped together with other departments.

CC Total
25,714 90,000
25,000 87,500 2,500 unfavorable overhead spending variance
37,500 100,000 (12,500) favorable overhead efficiency variance

but has overall performed efficiently contrary to the previous analysis

iency variance
Case Study in Activity Based Management
Dilbert Laboratories Limited

Facts of the case

The company manufactures three (3) products AA, BB, and CC.
In the past, the company had allocated company overhead using predetermined rates as follows:
Production Costs: Based on direct labour costs.
Selling and Administrative Costs: Based on number of units.

The management accountant has decided to use an activity based costing system to allocate overheads in the coming year.

Activities Identified Cost Type Cost Driver

Sales order processing Selling and Admin No. of Orders
Materials purchasing Production No. of Purchase Orders
Inventory Management Production No. of Parts per Unit
Machine Set-Up Production Set-Up Hours
Other Production Overhead Production Machine Hours
Packing and Delivery Selling and Admin No. of Deliveries
Total

BUDGET

Products AA BB
Budgeted Units 100,000 50,000

Budgeted Driver Units

No. of Sales Orders per product 20 50
No. of Purchase Orders per product 30 20
No. of Parts per Unit 6 8
Set-Up Hours per Product 50 80
Machine Hours per Unit 6 8
No. of Deliveries per product 20 60

Budget Direct costs per Unit

Direct Materials 5 8
Direct Labour 3 4
Selling Price per Unit 15 25

ACTUAL

Products AA BB
Actual Production 100,000 50,000

Actual Driver Units

No. of Sales Orders per product 20 50
No. of Purchase Orders per product 30 20
No. of Parts per Unit 6 8
Set-Up Hours per Product 50 80
Machine Hours per Unit 6 8
No. of Deliveries per product 20 60

Activities Identified Cost Driver Actual Overhead

Sales order processing No. of Orders 50,000
Materials purchasing No. of Purchase Orders 105,000
 Inventory Management No. of Parts per Unit 200,000
Machine Set-Up Set-Up Hours 120,000
Other Production Overhead Machine Hours 200,000
Packing and Delivery No. of Deliveries 170,000

Activities Identified Cost Driver Actual Overhead

Production Costs Direct Labor Costs 625,000
Selling and Administration No. of Units 220,000

Actual Direct Costs per Unit

Direct Materials 5 8
Direct Labour 3 4
Selling Price per Unit 15 25

REQUIREMENTS

1 Activities Identified Cost Driver Budgeted Overhead

Sales order processing No. of Orders 50,000
Materials purchasing No. of Purchase Orders 100,000
Inventory Management No. of Parts per Unit 200,000
Machine Set-Up Set-Up Hours 120,000
Other Production Overhead Machine Hours 200,000
Packing and Delivery No. of Deliveries 170,000

2 Activities Identified Cost Driver Budgeted Overhead

Production Costs Direct Labor Costs 620,000
Selling and Administration No. of Units 220,000

AA BB
Budgeted Cost per Unit
Direct Materials 5 8
Direct Labour 3 4
Overhead Allocated 5 6
Total 13 18

Budgeted Gross Profit Margin

Revenues 15 25
Cost of Sales 13 18
Gross Profit 2 7
Gross Profit Margin 15% 29%

3 Activities Identified AA BB
Sales order processing 2,703 6,757
Materials purchasing 37,500 25,000
Inventory Management 41,379 55,172
Machine Set-Up 21,429 34,286
Other Production Overhead 46,154 61,538
Packing and Delivery 8,947 26,842
Total 158,112 209,595
Budgeted Units 100,000 50,000
Budgeted Overhead per Unit 2 4

AA BB
Budgeted Cost per Unit
Direct Materials 5 8
 Direct Labour 3 4
Overhead Allocated 2 4
Total 10 16

Budgeted Gross Profit Margin

Revenues 15 25
Cost of Sales 10 16
Gross Profit 5 9
Gross Profit Margin 36% 35%

4 OLD

AA BB
Actual Production x Actual Rates 338,448 225,632
Actual Production x Budgeted Rates 332,143 221,429
Budgeted Production x Budgeted Rate 332,143 221,429

Again, in this scenario, we cannot completely evaluate whether the purchasing department has run efficiently.

NEW

AA BB
Actual Production x Actual Rates 39,375 26,250
Actual Production x Budgeted Rates 37,500 25,000
Budgeted Production x Budgeted Rate 37,500 25,000

Purchasing department had an unfavorable spending variance as it exceeded the expected cost of processing 30 orders for lesser units.
difference in activity, it met the expectations.
Budgeted Overhead Actual Overhead
50,000 50,000
100,000 105,000
200,000 200,000
120,000 120,000
200,000 200,000
170,000 170,000
840,000

CC Total
10,000 160,000

300 370
30 80
15 29
150 280
12 26
300 380

15
6
60

CC Total
9,000 159,000

300 370
30 80
15 29
150 280
12 26
300 380

Actual Units Cost per Diver Unit

370 135
80 1,313
 29 6,897
280 429
26 7,692
380 447

Budgeted Units Cost per Diver Unit

554,000 1.13
159,000 1.38

15
6
60

Budgeted Units Cost per Diver Unit

370 135
80 1,250
29 6,897
280 429
26 7,692
380 447

Budgeted Units Cost per Diver Unit

560,000 1.11
160,000 1.38

CC

15
6
8
29

60
29
31
52%

CC Total
40,541 50,000
37,500 100,000
103,448 200,000
64,286 120,000
92,308 200,000
134,211 170,000
472,293 840,000
10,000
47

CC

15
 6
47
68

60
68
(8)
-14%

CC Total
60,921 625,000
59,786 613,357 11,643 unfavorable overhead spending variance
66,429 620,000 (6,643) favorable overhead efficiency variance

CC Total
39,375 105,000
37,500 100,000 5,000 unfavorable overhead spending variance
37,500 100,000 - at par

ssing 30 orders for lesser units. However, in terms of efficiency, which only measures the