Activity Based Costing System

1. The Aeronautical Ltd. has production facility specializing in jobs for aircraft components market. The traditional costing system has 2 direct-cost categories, namely direct materials and direct manufacturing labour and a single direct cost pool, that is , manufacturing overhead allocated on the basis of direct labour hours . The indirect cost allocation rate would have been Rs. 115 , direct manufacturing labour hour. The company has now decided to replace the single indirect cost pool with 5 indirect cost pools, representing 5 activity areas each with its own supervising and budget responsibility. The relevant data are as follows:

Activity area Material handling Lathe work Milling

Cost driver used as an allocation base Parts Turns Machine hours

Cost allocation rate (in Rs.) 0.40 0.20 20.00

Grinding
Testing

Parts
Units tested

0.80
15.00

Two representative jobs processed under the new system of facility at the most recent period had the following features:

Particulars
Direct materials cost per job Direct manufacturing labour cost per job Parts per job Turns per job Machine hours per job Units per job

Job 101 (in Rs.)

9,700 750 500 20,000 150 10

Job 102 (in Rs.)

59,900 11,250 375 2,000 60,000 1,050 200

Direct manufacturing labour hours per job 25

Required: 1. Compute the per unit manufacturing costs of each job under the traditional job-cutting system. 2. Compute the per unit manufacturing costs of each job under the activity based costing system.

Solution: a) Manufacturing costs with traditional job costing system.

Particulars Job 101 (in Rs.) Job 102 (in Rs.)

Direct manufacturing costs per job

Direct materials per job 9700 59,900

Direct manufacturing labour per job Indirect manufacturing costs per job Total costs per job

750
10,450

11,250
71,150

25*115
2875

375*115
43,125

13,325

1,14,275

b) Manufacturing costs with activity based costing system. Particulars Job 101 (in Rs.) 9700 750 10,450 Job 102 (in Rs.) 59,900 11,250 71,150

Direct manufacturing costs per job

Direct materials per job Direct manufacturing labour per job a) Total Indirect manufacturing costs per job

b) Material handing c) Lathe work

d) Milling e) Grinding f) Testing

500*.40
200

2000*.40
800

20,000*.20
4000 150*20 3000 500*.80

60,000*.20
12000 1050*20 21,000 2000*.80

400
10*15 150 18,200

1600
200*15 3000 1,09,550

2. A company manufacturing 2 products furnishes the following data for a year :

Product Annual output Total (units) machine hrs. 5000 60,000 20,000 1,20,000 Total no. of purchase orders 160 384 Total no. of set-ups 20 44

A B

The annual overhead are as under:

Volume related activity costs Set-up related costs Purchase related costs Rs. 5,50,000 8,20,000 6,18,000

You are required to calculate the costs per unit of each product A & B based on : i) Traditional method of charging overheads ii) Activity based costing method.

Solution a) Statement showing costs per unit of product A&B based on traditional method:
Total annual overheads (Rs. 5,50,000+ 8,20,000+ 6,18,000) Total machine hrs. Machine hr rate (Rs. 19,88,000/1,40,000 hrs.) Particulars Annual output (units) Total machine hrs. Overhead cost Overhead cost per unit *(20,000 X Rs. 14.20) #(Rs. 2,84,000/5,000 units) A 5000 20,000 Rs. 2,84,000* Rs. 56.80 # **(1,20,000 X Rs. 14.20) ##(Rs. 17,04,000/60,000 units) 19,88,000 1,40,000 14.2 B 60,000 1,20,000 Rs. 17,04,000** Rs 28.40 ##

b) Statement showing costs per unit of product A&B based on Activity based costing method:
Machine hr rate (Rs. 5,50,000/1,40,000 hrs.) Cost of one set up (Rs. 8,20,000/ 64 setups) Rs. 3.93 12,812.50

Cost of purchase order (Rs. 6,18,000/ 544 orders)

Particular Total machine hrs. Cost related to volume activities Cost related to purchases Cost related to setups Total costs Annual output units Cost per unit A 20,000 Rs. 78,600*

1,136.03
B 1,20,000 4,71,600** Rs.4,36,235.52 ## Rs. 5,63,750 @@ 14,71,585.52 () 60,000 Rs. 24.53

Rs. 1,81, 764 # 2,56,250 @ 5,16,614.80 () 5000 Rs. 103.32

* (20,000 hrs X Rs. 3.93) ** (1,20,000 hrs X Rs. 3.93) # (160 orders X Rs. 1,136.03) ## (384 orders X Rs. 1,136.03) @ (20 setups X Rs. 12,812.50) @@(44 setups X Rs. 12,812.50)

3. Bright light ltd. manufactures 2 products: bright and delight, using the same equipment and similar process. The following information is extracted from the production deptt. Pertaining to the 2 products for the quarter ending 31 Dec, 2007:
Particulars
Qty produced (units) Direct labor hrs per unit Machine hrs per unit

Bright
10,000 2 3

Delight
15,000 4 1

No. of setups in the prd.

No. of orders handled in the prd.

20
30

80
120

Total productions overheads recovered for the prd. has been analysed as follows:
Particulars Relating to machine activity Relating to production run setups Relating to handling orders Rs. 4,50,000 40,000 90,000 5,80,000

Calculate the production overheads to be absorbed by each unit of the products using the following costing methods: a) A traditional costing approach, using direct labour hr. rate to absorb overheads. b) An ABC approach, using suitable cost drivers to trace overheads to products. Solution
a) Traditional costing Direct labor hrs (DLH) Bright (10,000units*2 hrs.) Delight (15,000 units* 4 hrs.) 20,000 hrs. 60,000 hrs. 80,000 hrs

So, Overhead absorption rate = Rs. 5,80,000/80,000 hrs = Rs. 7.25 Overhead absorbed would be as follows: Bright (2 hrs * Rs. 7.25) = Rs. 14.25 per unit Delight (4 hrs. * Rs. 7.25) = Rs. 29 per unit

b) Activity based costing (ABC)

Machine hrs (MH) Bright (10,000units* 3 hrs.) 30,000 hrs.

Delight (15,000 units* 1 hr.)

15,000 hrs.
45,000 hrs

Using ABC, the overhead costs are absorbed according to the cost drivers:
MH driven costs Setup driven costs Order driven costs Rs. 4,50,000/45,000 MH Rs. 40,000/100 Rs. 90,000/150 = Rs. 10 per MH = Rs. 400 per set up Rs. 600 per order

Particulars Machine driven costs

Setup costs Order handling costs Total costs Units produced Overhead costs per unit

Bright (Rs.) 30,000 hrs* Rs. 10

3,00,000 20 * Rs.400 8000 30 * Rs.600 18,000 3,26,000 10,000 Rs. 32.60

Delight (Rs.) 15,000 hrs*Rs. 10

1,50,000 80 * Rs. 400 32,000 120 * Rs.600 72,000 2,54,000 15,000 Rs. 16.93

Overhead costs

4. Modern India ltd. manufactures three products under the same production processes and equipments. A conventional product costing system is used at present, although an ABC system is being considered. The company has furnished the following information relating to the 3 products during the Yr. 2007-08:
Products A B C Production units 500 800 1200 Material cost Labour hrs per unit per unit Rs. 80 Rs. 70 Rs. 60 0.5 1 1.25 Machine hrs. per unit 0.75 1.5 2

Direct labour cost of the company is Rs. 60 per hr. According to the conventional method, the company absorbs production overheads on machine hr. basis. The rate for the period is Rs. 30 per machine hr. The production overhead costs for different activities are given below on the basis of percentage.

Activities
Setups Materials handling Machinery

%
20 20 30

Inspection
Total production activities

30
100

The volumes of activities associated with the products are given below:
Activities No. of setups No. of movements of materials No. of inspection A 18 20 15 B 12 25 12 C 20 30 18

Calculate the cost per unit for each product using ABC method.

Solution: ABC method:

Total production overhead costs based on machine hours weightage A B C Total 500 units * 0.75 hr. 800 units *1.5 hr. 1200 units * 2 hrs 375 hrs 1200 hrs 2400 hrs 3975 hrs

Production overhead cost = 3975 hrs * Rs 30 = Rs. 1,19,250

Cost of Activities Setups Materials handling Machinery Inspection Total production activities % 20 20 30 30 In Rs. 23,850 23,850 35,775 35,775 1,19,250

Allocation of activity-wise costs among products

Activities Setups (18:12:20) Materials handling (20:25:30) Machinery (375:1200: 2400) Inspection (15:12:28) Total (Rs.) 23,850 23,850 35,775 35,775 A (Rs.) 8586 6360 3375 11,925 B (Rs.) 5724 7950 10,800 9540 C (Rs.) 9540 9540 21,600 14,310

Total
No. of units Production overheads cost per unit (rounded off)

1,19,250

30,246
500

34,014
800

54,990
1200

60.00

43.00

46.00

Calculation of costs per product

Product cost per unit Materials Labour Production overheads Total A 80 0.5* Rs 60 30 60 170 B 70 1 * Rs 60 60 43 173 C 60 1.25 * Rs 60 75 46 181

4. Modern India ltd. manufactures three products under the same production processes and equipments. A conventional product costing system is used at present, although an ABC system is being considered. The company has furnished the following information relating to the 3 products during the Yr. 2007-08: