Activity based costing

1. Nikita Bhatkar
Operations Specialization

2. Activity-based costing (ABC) is a costing methodology that identifies activities in an organization
and assigns the cost of each activity with resources to all products and services according to the
actual consumption by each.
Resources are assigned to activities, and activities to cost objects based on consumption estimates.
The latter utilize cost drivers to attach activity costs to outputs
It enables a business to decide which products, services, and resources are
increasing their profitability, and which are contributing to losses

3. Usefulness for ABC Implementation
• ABC helps to identify inefficient products, departments and activities.
• ABC helps to allocate more resources on profitable products, departments and activities.
• ABC helps to control the costs at any per-product-level level and on a departmental level.
• ABC helps to find unnecessary costs that may be eliminated.
• ABC helps fixing the price of a product or service with any desired analytical resolution

4. Reasons for ABC implementation
• Better Management
• Budgeting, performance measurement
• Calculating costs more accurately
• Ensuring product /customer profitability
• Evaluating and justifying investments in new technologies
• Improving product quality via better product and process design
• Increasing competitiveness or coping with more competition
• Management
• Managing costs
• Providing behavioral incentives by creating cost consciousness among employees

5. The implementation of the ABC system has the following steps:
Step 1) Identifying the activities such as machining, inspection etc.
Step 2) Determining the activity costs
Step 3) Determining the cost drivers such as machining hours, number of setups,
labour hours etc.
Step 4) Collecting the activity data
Step 5) Computing the product cost

6. A Comparative Analysis and Implementation of
Activity Based Costing (ABC)
and
Traditional
Cost Accounting (TCA) Methods
in an
Automobile Parts Manufacturing Company:
A Case Study
A CASE of:
Nitin Kumar & Dalgobind Mahto
Global journal of Management and Business Research
Volume XIII Issue IV Version I
Year 2013

7. Current status:
Current prices, direct labour hour to produce each of the items, their material costs, and
annual production quantities are as under and are shown
Sr. No. Object Part A Part B Part C
1 Material cost 400 250 300
2 Direct labour hours 5 3.7 4.5
3 Annual quantity 18000 16000 18500
4 Selling Price/each 1200 each 850 each 1150 each

8. The company has recorded following expenses last year on its General Ledger Statement and it is
shown
(a) Direct labour 1,67,50,000.00
(b) Direct material 24,58,000.00
(c) All other indirect expenses Salaries & wages 35,43,650
Fringe benefits 9,48,328
Utilities 5,17,837
Income tax 1,58,121
Equipment rental 4,30,491
Postage 31,195
Depreciation 2,93,233
Property tax 74,868
Maintenance 1,18,541
Property insurance 56,151
Tools 93,585
Total 62,66,000

9. In Traditional costing method
Total Labour hours required
Part A = (18,000 × 5) = 90,000 hrs
Part B = (16,000 × 3.7) = 59,200 hrs
Part C = (18,500 × 4.5) = 83,250 hrs
Total labour hours = 2, 32,450 hrs
Direct labour hour cost
Direct labour hour cost = (1,67,50,000/2,32,450) = 72.05 ₹/hr
Total/overall indirect cost
Total indirect cost = 62,66,000
Over cost/labour hour
Over cost/labour hour = (62,66,000.00/2,32,450) =26.95 ₹/hr

10. Part Cost Calculation in traditional costing
S.NO. Expenses Part A Part B Part C
1 Direct material 400 250 300
2 Direct labour (72.05×5) = 360.25 (72.05×3.7) = 266.59 (72.05×4.5) = 324.23
3 Overhead (26.95×5) = 134.75 (26.95×3.7) = 99.72 (26.95×4.5) = 121.28
4 Total cost 895 616.31 745.51
5 Price 1200 850 1150
6 Margin 305 233.69 404.49
7 Margin % 25.41 27.50 35.18
Thus, Part “C” has the best margin % i.e. 35.18%.

11. Now, True Cost calculation of parts by Activity Based Costing (ABC) Method :
Flashback…….

12. After interviewing the staff of company;
some of the information was received from the Company’s records
Sr. No. Object Part A Part B Part C Total
1 Customer orders 1,800 2,000 2,500 63,00
2 Parts manufactured 18,000 16,000 18,500 52,500
3 Work orders 110 100 120 330
4 Set-ups 110 100 120 330
5 Machine hours/unit 5 3.7 4.5
6 Material cost/unit 400 350 200
7 Labour hours/unit 5 3.7 4.5
8 Total labour hours 18,000 16,000 18,500
9 Selling price/part 1,200 850 1,150

13. Activity determination : The staff questionnaire revealed that the company uses 25
employees and they are in the following work groups as shown
Sr. No. Activity No. of People % of total
1 Processing orders 12 24%
2 Scheduling orders 10 20%
3 Die maintenance and storage 14 28%
4 Inspection 08 16%
5 Shipping (dispatch) orders 06 12%
6 Total 50 100%

14. Calculation of unit activity costs :
S.NO. Activities Activity cost Activity driver Quantity Cost/unit
1 Processing orders 15,03,840 No. of orders 6,300 238.70
2 Scheduling orders 12,53,200 No. of work orders 330 3,797.57
3 Set-up machines 17,54,480 No. of set-ups 330 5,316.60
4 Inspection lots 10,02,560 No. of lots 330 3,038.06
5 Shipping part 7,51,920 No. of shipments 6,300 119.35
Note : Activity Costs Calculation
Total indirect cost from general ledger × % activity
e.g., Processing orders = 62, 66,000 × 0.24
= 15, 03,840

15. Activity Costs :
Part A Part B Part C
Sr.
No
Activity Cost Vol. Total Cost Unit
Cost
Vol. Total
Cost
Unit
Cost
Vol. Total Cost Unit
Cost
1 Processing
Orders
238.70 1,800 4,29,660 23.87 2,000 4,77,400 29.83 2,500 5,96,750 32.25
2 Scheduling
Orders
3,797.57 110 4,17,732.7 23.20 100 3,79,757 23.73 120 4,55,708.4 24.63
3 Set-up
machines
5,316.60 110 5,84,826 32.49 100 5,31,660 33.22 120 6,37,992 34.48
4 Inspection
lots
3,038.06 110 3,34,186.6 18.56 100 3,03,806 18.98 120 36,45,67.2 19.70
5 Shipping
parts
119.35 1,800 2,14,830 11.93 2,000 2,38,700 14.91 2,500 2,98,375 16.12
6 Total 110.05 119.67 127.18

16. Calculation of “true” costs of all three parts :
Sr.No. Expenses Part A Part B Part C
(1) Direct material 400 250 300.00
(2) Direct labour 360.25 266.59 324.23
(3) Overhead distribution (activity cost basis ) 110.05 119.67 127.18
(4) Total cost {=(1)+(2)+(3)} 870.03 636.26 751.41
(5) Selling price 1200 850 1150
(6) Margin{=(5)-(5)} 329.97 213.74 398.59
(7) Margin % 27.49% 25.14% 34.66%

17. Comparison
PART Selling price TCA cost TCA margin TCA margin% ABC cost ABC cost margin ABC cost margin%
Part “A” 1,200 895 305 25.41% 870.03 329.97 27.49%
Part “B” 850 616.31 233.69 27.50% 636.26 213.74 25.14%
Part “C” 1,150 745.51 404.49 35.18% 751.41 398.59 34.66%