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  • Activity Based Costing

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    Ayushi Nagori
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    The document discusses activity-based costing (ABC) and compares it to the traditional costing method. Under the traditional method, overhead costs are allocated using a single predetermined overhead rate based on direct labor hours. In contrast, ABC assigns overhead costs to products based on their use of resources and activities. The document provides an example where a company manufactures two products and calculates their unit costs under both the traditional and ABC methods. It finds the unit costs differ substantially between the two methods. Specifically, Product A appears cheaper under the traditional method while Product B appears more costly. As ABC is considered more accurate, relying on the traditional method could lead to underpricing some products and overpricing others, resulting in lost sales and profits for the

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    Cost Accounting Project.

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    The document discusses activity-based costing (ABC) and compares it to the traditional costing method. Under the traditional method, overhead costs are allocated using a single predetermined overhead rate based on direct labor hours. In contrast, ABC assigns overhead costs to products based on their use of resources and activities. The document provides an example where a company manufactures two products and calculates their unit costs under both the traditional and ABC methods. It finds the unit costs differ substantially between the two methods. Specifically, Product A appears cheaper under the traditional method while Product B appears more costly. As ABC is considered more accurate, relying on the traditional method could lead to underpricing some products and overpricing others, resulting in lost sales and profits for the

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pptx, pdf, or txt
    8 views13 pages

    Activity Based Costing

    Uploaded by

    Ayushi Nagori
    The document discusses activity-based costing (ABC) and compares it to the traditional costing method. Under the traditional method, overhead costs are allocated using a single predetermined overhead rate based on direct labor hours. In contrast, ABC assigns overhead costs to products based on their use of resources and activities. The document provides an example where a company manufactures two products and calculates their unit costs under both the traditional and ABC methods. It finds the unit costs differ substantially between the two methods. Specifically, Product A appears cheaper under the traditional method while Product B appears more costly. As ABC is considered more accurate, relying on the traditional method could lead to underpricing some products and overpricing others, resulting in lost sales and profits for the

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pptx, pdf, or txt
    of 13

    ACTIVITY BASED COSTING

    MANUFACTURING SECTOR

    INTRODUCTION

    In Manufacturing three types of costs


    are included:
    1.

    Material Cost (Direct Cost)

    2.

    Labor Cost (Direct Cost)

    3.

    Manufacturing Cost (Overhead Cost)

    Direct cost are chargeable to end


    product without any difficulty

    Indirect cost creates problems in


    determining the accurate product cost

    FLOW OF MANUFACTURING COST

    APPROACH

    Indirect cost can be allocated and apportioned by any of the


    following two approaches:
    1.

    Traditional approach

    2.

    Activity Based Costing approach

    COMPARISON
    Traditional approach

    RESOURCE
    COSTS

    Directly
    traced or
    allocated
    Cost Pools:
    Plants or
    Departments
    Predetermin
    ed
    Cost
    overhead
    Objective
    rate

    ABC approach

    RESOURCE
    COSTS

    Cost Pools:
    Activities or
    Activities
    centers

    Cost
    Objective

    Directly
    traced or
    allocated

    Cost driver
    rates for
    each
    activity

    Shift from Traditional to ABC approach

    Since traditional costing uses average overhead rate for all activities it
    lead to under costing of certain product and over costing of other products

    Need to measure more accurately how different products or services use


    company resources has led to more refined costing system know as ABC

    ABC is:

    Accurate and reliable


    Better pricing decision
    Realistic
    Control of cost
    Greater cost efficiency

    PROBLEM
    Major Ltd. manufactures two products A and B. The product A is a low-volume
    item and its sales are 5000 units p.a. The product B is a high volume item and
    its sales are 20000 units p.a. Both products require two direct labor hours for
    completion. The company works 50000 direct labor hours each year as given
    below:
    Hours
    Product A: 5000 units x2
    hours

    10000

    Product B: 20000 units x 2


    hours

    40000

    Total Hours

    50000

    PROBLEM
    Details of costs for material and labor for each product (per unit) are given
    below:
    Product

    Direct Material

    Rs. 25

    Rs. 15

    Direct Labor (@ Rs 5 per


    hour)

    10

    10

    The companys total manufacturing overheads cost are Rs 8,75,000 per annum.
    The company has analyzed its operations and has determined that five activities
    act as cost drivers in the incurrence of overhead costs. Data relating to the five
    activities are as follows:

    PROBLEM
    Activity

    Traceabl
    e Cost
    (in Rs.)

    Total

    Product A

    Product B

    Machine Set up

    2,30,000

    5,000

    3,000

    2,000

    Quality
    Inspection

    1,60,000

    8,000

    5,000

    3,000

    Production
    Order

    81,000

    600

    200

    400

    3,14,000

    40,000

    12,000

    28,000

    90,000

    750

    150

    600

    Machine hours
    worked
    Material
    receipts

    SOLUTION

    Traditional Method
    Produc
    tA

    Product B

    Units
    Produced

    5000

    20000

    Overhead
    Absorption rate:

    Direct
    Material

    25

    15

    Direct Labor

    10

    10

    8,75,000
    50,000 labor
    hrs.

    Prime Cost

    35

    35

    Over Head

    35

    35

    Product
    Cost

    70

    60

    =17.5 per labor


    hrs.

    SOLUTION

    Overhead calculation for ABC


    Activity

    Total Cost
    apportione
    d (per
    unit)

    Product A

    Product B

    Machine Set up

    46

    1,38,000

    92,000

    Quality Inspection

    20

    1,00,000

    60,000

    135

    27,000

    54,000

    7.85

    94,200

    2,19,800

    120

    18,000

    72,000

    3,77,200

    4,97,800

    5000

    20000

    75.44

    24.89

    Production Order
    Machine hours
    worked
    Material receipts
    Total
    Units Produced
    Over Head Cost

    SOLUTION

    ABC Method
    Produc
    tA

    Product B

    Direct
    Material

    25

    15

    Direct Labor

    10

    10

    Prime Cost

    35

    35

    Over Head

    75.44

    24.89

    Product
    Cost

    110.44

    49.89

    SUMMARY
    COST OF PRODUCTION PER UNIT
    Product A

    Product B

    Traditional Method

    70

    60

    ABC Method

    110.44

    49.89

    Statements of cost prepared under traditional method and ABC method


    produces different results. Under traditional method Product A does not
    cheaper then compared to in ABC method, where as Product B appears more
    costly compared to latter method. As ABC approach is considered more
    logical, it may be presumed that results produced by ABC are more accurate.
    If selling price is fixed on the basis of cost, product A would be priced lower
    and Product B will be priced higher in traditional approach. This will lead to
    loss of sale of product B and loss of per unit of product A, leading to a loss to
    the company

    THANK YOU

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