Activity Based Costing 1

ACTIVITY BASED COSTING
What are overheads
All indirect expenses
Do overheads form a part of cost
The answer is yes
But how to decide how much overhead is part of cost of goods

TRADITIONAL METHOD
OVERHEA
D COST COST
CENTRES OBJECT
COST
Allocation and ABSORBTION

apportionment
Overheads = ₹ 4,00,000
Two department A and B (ratio 5 : 3)
A = 4,000 labour hours

B = 5,000 machine hours
Apportionment : A = ₹ 2,50,000
B = ₹ 1,50,000
Absorption rate = A = ₹ 2,50,000 / 4,000 = ₹ 62.50

B = ₹ 1,50,000 / 5,000 = ₹ 30
Product Z =
200 hrs in department A and 300 in department B
Cost = 200 * 62.50 + 300 * 30 = 12,500 + 9,000 = 21,500

Overheads = ₹ 4,00,000
Set up cost : ₹ 1,00,000

Material handling cost : ₹ 2,00,000
Machine related cost : ₹ 1,00,000
Number of set up = 50
Number of times material handled : 500
Machine hours = 5,000
Rate as per activity

Set up cost : ₹ 1,00,000 / 50 = ₹2,000 per set up
Material handling cost : ₹ 2,00,000 / 500 = ₹ 400 per handling
Machine related cost : ₹ 1,00,000 / 5,000 = ₹ 20 per hour
Product Z =
Number of set up = 5
Number of times material handled : 30
Machine hours = 300
Total cost = 5 *2000 + 30 * 400 + 300 * 20 = 28,000

OVERHEA
ACTIVITIE COST
D
S UNIT
COST
MEANING
 The Activity-Based Costing (ABC) is a costing system, which focuses

on activities performed to produce products.
 ABC is that costing in which costs are first traced to activities and then
to products.
 This costing system assumes that activities are responsible for the
incurrence of costs and create the demands for activities.
MEANING OF TERMS USED IN ABC
(i) Activity - Activity, here, refers to an event that incurs cost.
(ii) A Cost Object-It is an item for which cost measurement is required e.g. a
product or a customer.
(iii) A Cost Driver-It is a factor that causes a change in the cost of an activity. There
are two categories of cost driver. Example Production runs
• A Resource Cost Driver- It is a measure of the quantity of resources consumed by
an activity. It is used to assign the cost of a resource to an activity or cost pool.
• An Activity Cost Driver-It is a measure of the frequency and intensity of demand,
placed on activities by cost objects. It is used to assign activity costs to cost objects.
(iv) Cost Pool-It represents a group of various individual cost items. It consists of
costs that have same cause effect relationship. Example Machine set-up.
OVERHEA
ACTIVITIE COST
D
S UNIT
COST
RESOURCE COST ACTIVITY COST

DRIVER DRIVER
LEVEL OF ACTIVITIES
Unit level
• These are those activities for which the consumption of resources can be
identified with the number of units produced.
Batch level
• The cost of batch related activities varies with number of batches made, but is
common (or fixed) for all units within the batch
Product level
• These are the activities which are performed to support different products in
product line
Facility level
• These activities are necessary to sustain the manufacturing process and are
common and joint to all products manufactured
Steps in activity based costing
Identify the
different The activity
activities Determine the driver rate can
within the activity cost be used to cost
organisation drivers products
Relate the Calculate

overheads to activity cost
the activities driver rates
MST Ltd has collected the following data for its two activities. It calculates
activity cost rates based on the Cost Driver capacity.
Activity Cost Driver Capacity Cost

Power Kilowatt Hours 50,000 Kilowatt Rs. 2,00,000
hours
Quality Inspections Number of 10,000 inspections Rs. 3,00,000
Inspections
Computation of ABC Cost Driver Rates
(a) Power = = = = Rs. 4 per kwh
(b) Quality Inspections = = = Rs. 30 per inspection

The Company makes three products - M, S and T. For the year ended
31st March, the following consumption of Cost Drivers was reported -
Product Kilowatt hours Quality Inspection
M 10,000 3,500
S 20,000 2,500
T 15,000 3,000
Computation of Allocated Costs / Unused Capacity
Product Kwh
M 10,000
S 20,000
T 15,000
Product Kwh Cost at Rs. 4

per kwh
M 10,000 40,000
S 20,000 80,000
T 15,000 60,000
Product Kwh Cost at Rs. 4 Quality

per kwh Inspections
M 10,000 40,000 3,500
S 20,000 80,000 2,500
T 15,000 60,000 3,000
Product Kwh Cost at Rs. 4 Quality Cost at Rs. 30

per kwh Inspections per Inspection
M 10,000 40,000 3,500 1,05,000
S 20,000 80,000 2,500 75,000
T 15,000 60,000 3,000 90,000
Product Kwh Cost at Rs. 4 Quality Cost at Rs. 30 Total Cost

per kwh Inspections per Inspection (Rs.)
M 10,000 40,000 3,500 1,05,000 1,45,000
S 20,000 80,000 2,500 75,000 1,55,000
T 15,000 60,000 3,000 90,000 1,50,000

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ACTIVITY BASED COSTING

What are overheads

All indirect expenses

Do overheads form a part of cost

The answer is yes

But how to decide how much overhead is part of cost of goods

Allocation and ABSORBTION

Two department A and B (ratio 5 : 3)

A = 4,000 labour hours

Absorption rate = A = ₹ 2,50,000 / 4,000 = ₹ 62.50

Cost = 200 * 62.50 + 300 * 30 = 12,500 + 9,000 = 21,500

Set up cost : ₹ 1,00,000

Rate as per activity

Total cost = 5 *2000 + 30 * 400 + 300 * 20 = 28,000

 The Activity-Based Costing (ABC) is a costing system, which focuses

(i) Activity - Activity, here, refers to an event that incurs cost.

RESOURCE COST ACTIVITY COST

Relate the Calculate

Activity Cost Driver Capacity Cost

Product Kwh Cost at Rs. 4

Product Kwh Cost at Rs. 4 Quality

Product Kwh Cost at Rs. 4 Quality Cost at Rs. 30

Product Kwh Cost at Rs. 4 Quality Cost at Rs. 30 Total Cost

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Total cost = 5 2000 + 30 400 + 300 * 20 = 28,000