Activity-Based Costing

Dr.M.Venkateshwarlu

Pen Production at Camel Co

Production Volume
Black Pen
Pink Pen
Neon Pen
Total
Mfg O/H
Machine Depreciation
Machine Setup
Material Handling
Total Mfg O/H
Volume-Based Allocation
Black
Mfg O/H
Rs
98,000
Mfg O/H per unit
Rs 1

98,000 units
1,000
1,000
100,000 units

Rs

Rs

Pink
1,000
Rs 1

40,000
30,000
30,000
100,000

Neon
1,000
Rs 1

Actual Cost
Black
Depreciation Rs
Setup
Handling
Total O/H

39,200
10,000
10,000
59,200

Pink
400
10,000
10,000
20,400

Neon
400
10,000
10,000
20,400

O/H per unit

Rs 0.6 Rs 20.4 Rs 20.4
Note:
Therefore, Costs are driven by volume as well as
complexity.

Activity-Based Costing
By
accounting
for
complexity
in
manufacturing process, ABC reduces the
distortion in product costing.
To account for complexity, ABC approach
identifies major activities in manufacturing
process.

Traditional Costing
Mfg O/H
Cost Pool

ABC
Mfg O/H
Cost Pool

Activity 1

Product 1 Product 2 Product 3

Activity 2

Activity 3

Product 1 Product 2 Product 3

ABC at Camel Co
Mfg O/H = Rs100,000

Machinery
Rs 40,000

Machine
Setup
Rs 30,000

Black

Pink

Material
Handling
Rs 30,000

Neon

Steps for ABC Implementation

1.
2.
3.
4.

Identify significant activities

Assign O/H costs to activity cost pools.
Find the cost driver for each activity.
Compute the cost rate for each activity
cost pool.
5. Allocate activity costs to each product
using the cost rate.

A Construction Ltd , O/H Costs

Indirect materials
Indirect labor:
Construction supervisor
Office staff
Part-time workers
Other overhead:
Office expenses
Tools
Trucks & other equipment
Rent on construction trailer
Total

Rs

180,000
130,000
30,000
30,000

Rs

48,000
15,000
40,000
12,000
485,000

Traditional Costing
POR =
Cost
DM
DL
O/H
Total

Overhead Cost
=
Direct Labor Hours

Rs 485,000
88,000 DLH

= Rs 5.51/DLH

Standard Product
Custom Product
Rs 75,000
Rs
112,500
60,000 (2,400hr*Rs25)
100,000 (4,000hr*Rs25)
13,224 (2,400hr*Rs5.51)
22,040 (4,000hr*Rs5.51)
Rs 148,224
Rs
234,540

Sale Price Rs 178,000

(20% Markup)

Rs

281,500

ABC at A LTD
Activities(1)
Est. Cost Pool(2)
Inspections
Rs
50,000
Purchasing
30,000
Supervising
100,000
Material handling
225,000
Processing change orders
80,000
Total
Rs 485,000

Step 3 Cost Driver

Activity

Cost Driver

Est. Cost

Driver Activity

Inspection
Purchasing
Supervision
Material
Change order

# of inspection
# of purchase
hrs of supervision
# of deliveries
# of change order

1,400
1,200
4,000
1,200
500

Step 4 O/H Cost Rate

Activity

Est Cost

Inspection Rs 50,000
Purchasing
30,000
Supervision 100,000
Material
225,000
Change
80,000

Est Driver Vol

1,400
1,200
4,000
1,200
500

Cost Rate
Rs
Rs
Rs
Rs
Rs

35.71
25
25/hr
187.5
160

Step 5 - Application
Products
DM
DL

Standard
75,000
60,000
Inspection (Rs35.71)
714
Purchasing (Rs25)
750
Supervision (Rs25)
3,125
Material (Rs187.5)
5,625
Change (Rs160)
1,600
Total
146,814

Custom
112,000
100,000
3,571
1,500
3,750
11,250
4,800
237,371

ABC
Benefits

Costs

Accurate Costing

Costly Implementation

Activity Evaluation

Costly Maintenance

Value-Added Activity
Non-Value-Added
Activity

Better Cost Control

Where ABC works well

Diverse Products
High Overheads
Diverse Product Cost Structures
Pricing Problems

Service Industry & ABC

Popular!
Financial Service, Insurance, Bank
Hotel, Hospital, Airline

Why so successful?
Services are diverse and customized.

Caveats
Very diverse activities
Large portion of facility-level costs

The End