1220 Views

Estimated reading time : 549 Minutes

Activity Based Costing | Cost Drivers | Problems and Solution

Arjun EP

Published on: January 26, 2022

Activity Based Costing | Concept of ABC

Direct materials and direct labour are the major elements of traditional cost accounting system.

The traditional system is suitable for those companies who produce goods in narrow range.

If company produces wide range of goods, overhead cost will be relatively higher to the direct cost.

And it may be difficult to allocation (share) fixed cost.

Activity based cost (ABC) was introduced by Robin Cooper in 1980 to resolves the difficulties of assigning overhead amount under traditional costing.

Then Robert S. Kaplan recommended it in 1988; it is recommended for:

· A wide range of products

· Product costing and profitability

· Distribution and controlling overheads appropriately (properly)

ABC helps to better understanding about overhead cost.

It helps to allocation overheads in systematic and scientific way.

Activities are transaction, events, tasks or unit of work for producing goods.

ABC is also called transaction based costing.

Definition of ABC

According to Professor Robin Cooper and Robert S. Kaplan, “ABC systems calculate the costs of individual activities and assign/allocate costs to cost objects such as product and service on the basis of activities and assign costs to cost each product or service.”

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Machine expenses	xxxx	Machine hour	xxx	xxx
Set up cost	xxxx	Production runs	xxx	xxx
Store receiving cost	xxxx	Requisition raised	xxx	xxx
Quantity control	xxxx	Production runs	xxx	xxx
Materials handling	xxxx	Order executed	xxx	xxx

Cost Statement under ABC

Particulars			X	Y	Z
Direct materials		[Output × Usage × MCPU]	xxxx	xxxx	xxxx
Direct labour		[Output × DLH × $]	xxxx	xxxx	xxxx
Prime cost			xxxx	xxxx	xxxx
Add: Overhead (based on ABC)
Machine expenses	[Machine hour × $]		xxxx	xxxx	xxxx
Set up cost	[Production runs × $]		xxxx	xxxx	xxxx
Store receiving cost	[Requisition raised × $]		xxxx	xxxx	xxxx
Quantity control	[Production runs × $]		xxxx	xxxx	xxxx
Materials handling	[Order executed × $]		xxxx	xxxx	xxxx
Total cost			$xxxxx	$xxxxx	$xxxxx
Output			xxxx	xxxx	xxxx
Cost per unit = Total cost ÷ Output			$xx	$xx	$xx

Limitation of Activity Based Costing

Following are the main limitations of ABC:

ABC is more complex than traditional costing system.

It is difficult to identify overall activities.

It is difficult to select most suitable cost driver for each expenses or overhead.

It is not suitable for small manufacturing industries because it is expensive.

Working procedure of activity based costing system

Step 1, Identify the major activities of an organization

Step 2, Identify a cost driver (cost indicator) for each activities or operation

Step 3, Create a cost center (cost pool) for each major activity or operation

Step 4, Trace (allocate) the cost of the activities or operation to the final product

Step 1, Identify the major activities of an organization

To prepare finished goods, every manufacturing company needs some basic components like materials, materials handling, work in progress, machine operation, production scheduling, production runs, set-ups, employees’ related activities, customer’s order completing dispatch of goods etc.

Step 2, Identify a cost driver (cost indicator) for each activities or operation

Cost is influenced/effected by different factors.

After identification of the major activities, those effecting factors also should be identified; they are:

SN	Activities or Transactions	Cost Drivers
1.	Material procurement, Order execution	No. of order
2.	Material handling	No. of order executed, No. of movement
3.	Store	No. of batch, Requisition raised
4.	Materials handling and dispatch	Order executed, No. materials component, volume
5.	Dispatch of goods	No. of dispatches
6.	Schedule cost, set up cost	Production runs
7.	Materials inspections	No. of inspections
8	Repair and maintenance, short term variable cost	Machine hours
9.	Power	Horse power
10.	Production scheduling	No. of production scheduling
11.	Engineering cost	No. of set up, No. of product change, No. of tool change

Traditional Costing System vs Activity Based Costing

Traditional costing

The tradition costing system was designed decades ago for costing.

There are two types of distribution under traditional costing system.

They are primary and secondary distribution of overhead.

Under primary costing, direct materials, direct labour and direct overhead are calculated.

Under secondary costing, labour hour based or machine hour based overhead are calculated.

Activity based costing

ABC helps to better understanding about overhead cost.

It helps to allocation overheads in systematic and scientific way.

Activities are transaction, events, tasks or unit of work for producing goods.

ABC is also called transaction based costing.

Traditional Costing System vs Activity Based Costing

Bases	Traditional Costing System	Activity Based Costing
Cost driver	There is a single cost driver in traditional costing system	There are multiple cost drivers in activity based costing.
Usage	It is used when labour or machine cost is the large portion of the product cost.	It is used when technology is the large portion of the product cost.
Costing method	It is more expensive costing method.	It is less expensive costing method.
Scope	Traditional costing can be used only for manufacturing overheads.	ABC can be used in manufacturing as well as non-manufacturing overheads like administration and selling.
Reporting	The values cannot be used in reports of external reporting.	The values can be used in external financial statements.
Implement	It is straightforward and easy to implement.	It is difficult to implement and requires time and effort.

Step 3, Create a cost center (cost pool) for each major activity or operation

After finding out cost driver, cost driver rate should be calculated.

Cost driver rate = Related overhead ÷ Related total overhead

Step 4, Trace (allocate, distribution) the cost of the activities

After finding out cost driver rate, those should be allocated according to their nature or basis.

Overhead or activity = Cost driver x Cost driver rate

Keep in Mind (KIM)

According to CIMA, ‘Cost driver is any factor which causes a change in the cost of an activity”.

Examples:

In marketing, cost drivers are number of advertisements, number of sales personnel etc.

In customer service, cost drivers are number of service calls attended, number of staff in service department, number of warranties handled, Hours spent on servicing etc.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

ABC Manufacturing Company (P) Ltd has following data:

Activities	Overhead (in $/₹/Rs)	Cost driver
Procurement cost	20,000	No. of order
Repair and maintenance	60,000	Machine hours
Set up cost	18,000	No. of production runs
Materials handling	12,000	No. of order executed

Output and relevant data are:

Products	Output units	No. of order	Machine hours	Production runs	No. of order executed
A	1,000	40	15,000	3	200
B	1,500	60	10,000	5	400

Required: (under ABC) (1) Cost driver rate; (2) Total overhead; (3) Overhead rate

[Answer: CDR: $200; $2.40; $2,250; $20;

Total overhead: A = $54,750; B = $22,250;

Overhead rate: A = $54.75; B = $36.83]

SOLUTION:

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Procurement cost	20,000	No. of order	100	200.00
Repair and maintenance	60,000	Machine hours	25,000	2.40
Set up cost	18,000	No. of production runs	8	2,250.00
Materials handling	12,000	No. of order executed	600	20.00

Working note for total cost driver:

No. of order	Machine hours	Production runs	No. of order executed
= A + B	= A + B	= A + B	= A + B
= 40 + 60	= 15,000 + 10,000	= 3 + 5	= 200 + 400
= 100	= 25,000	= 8	= 600

Cost Statement under ABC

Particulars		A	B
Direct materials	[Output × Usage × MCPU]	xxxx	xxxx
Direct labour	[Output × DLH × $xx]	xxxx	xxxx
	Prime cost	xxxx	xxxx
Add: Overhead	(based on ABC)
Procurement cost	[No. of order × $200]	8,000	12,000
Repair and maintenance	[Machine hours × $2.40]	36,000	24,000
Set up cost	[No. of production runs × $2,250]	6,750	11,250
Materials handling	[No. of order executed × $20]	4,000	8,000
Total overhead		$54,750	$55,250
Output		1,000	1,500
Overhead per unit = Total overhead ÷ Output		$54.75	$36.83

Keep in Mind (KIM)

Overhead for product A	= CD x CDR
Procurement cost	[No. of order × $200]	= 40 x $200	= $8,000
Repair and maintenance	[Machine hours × $2.40]	= 15,000 x $2.4	= $36,000
Set up cost	[No. of production runs × $2,250]	= 3 x $2,250	= $6,750
Materials handling	[No. of order executed × $20]	= 200 x $20	= $4,000
All overhead related to ABC is calculated as above.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

XYZ Manufacturing Company produces its two products in similar machine and process. The following information is available:

Particulars	X	Y
Units produced	6,000	8,000
Labour hour per unit	1	2
Machine hour per unit	4	2
Set up periods	15	45
Order handling	12	60

Cost incurred (in $/₹/Rs):

Production set up cost	Order handling	Machine activity	Total overhead
180,000	32,400	60,000	272,400

Required: (1) Cost driver rate; (2) Total overhead under ABC; (3) Overhead cost per units based ABC

[Answer: CDR = $3,000; $450 and $1.50]

Total overhead = $86,400 and $186,000;

Overhead CPU = $14.40 and $23.25]

SOLUTION:

Working note for total cost driver

No. of set up	Order handling	Machine hours	= Output x LHPU
= X + Y	= X + Y	X	= 6,000 × 4	= 24,000
= 15 + 45	= 12 + 60	Y	= 8,000 ×2	= 16,000
= 60	= 72			= 40,000

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Production Set up	180,000	No. of set up	60	3,000.0
Order handling	32,400	Order handling	72	450.0
Machine activity	60,000	Machine hours	40,000	1.5

Cost Statement under Activity Based Cost (ABC)

Particulars		Products
		X = 6,000	Y = 8,000
Direct materials		xxxx	xxxx
Direct labour		xxxx	xxxx
Prime cost		xxxx	xxxx
Add: Overhead (based on ABC):
Production set up	[No. of set up × $3,000]	45,000	135,000
Order handling	[Order handling × $450]	5,400	27,000
Machine activity	[Machine hours × $1.50]	36,000	24,000
Total overhead		$86,400	$186,000
Output		6,000	8,000
Overhead cost per units = Total overhead ÷ Output		$14.40	$23.25

Keep in Mind (KIM)

If prime cost is available, sum of prime cost and overhead is called total cost.

If prime cost is not available, sum of overhead is called total overhead.

Upto prime cost both traditional costing and ABC costing have same value.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

Eshna Manufacturing produces its products in similar process. The expenses for the period were:

Cost overhead	Amount	Cost driver
Machine expenses	99,000	Machine hours
Schedule cost	165,000	Production runs
Set up cost	96,000	Production runs
Materials handling	137,700	No. components
	497,700

Four products were produced by workers. Wage rate per hour $12

Additional information:

Particulars	A	B	C	D
Output in units	500	800	1,000	1,500
No. of production runs	5	7	8	10
DLH per unit	3	5	3	5
Machine hour per unit	4	6	4	6
Materials cost per unit	60	40	50	20
No. of materials handling	10	8	12	15

Required: Total cost and cost per unit applying:

(a) Conventional costing using machine hour; (b) ABC using suitable cost driver

[Answer: (a) Total cost: A = $98,280; B = $200,672; C = 186,560; D = $346,260;

CPU: A = $196.50; B = $250.84; C = $186.56; D = $230.84;

(b) Total cost: A = $132,100; B = $189,380; C = 212,320; D = $297,900;

CPU: A = $264.20; B = $236.73; C = $212.32; D = $198.60]

SOLUTION:

Given and working note:

Total MH	= Output x MHPU		Machine hour rate
A	= 500 x 4	= 2,000	= Total overhead ÷ Total MH
B	= 800 x 6	= 4,800	= $497,700 ÷ 19,800 MH
C	= 1000 x 4	= 4,000	= $25.14
D	= 1,500 x 6	= 9,000
		19,800*

Cost Statement under Conventional Costing

Particulars	A = 500	B = 800	C = 1,000	D = 1,500
Direct materials [Output x MCPU]	30,000	32,000	50,000	30,000
Direct labour [Output x DLH x $12]	18,000	48,000	36,000	90,000
Prime cost	48,000	80,000	86,000	120,000
Add: Overhead (based on machine hour)
[Machine hour x Machine hour rate]	50,280	120,672	100,560	226,260
Total cost	$98,280	$200,672	$186,560	$346,260
Output	500	800	1,000	1,500
Cost per unit = Total cost ÷ Output	$196.56	$250.84	$186.56	$230.84

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Machine expenses	99,000	Machine hour	19,800*	5
Schedule cost	165,000	Production runs	30	5,500
Set up cost	96,000	Production runs	30	3,200
Materials handling	137,700	No. of Materials handling	45	3,060

Working note for total cost driver:

Total MH	= Output x MHPU		Production runs	No. of Materials handling
A	= 500 x 4	= 2,000	= A + B + C + D	= A + B + C + D
B	= 800 x 6	= 4,800	= 5 + 7 + 8 + 10	= 10 + 8 + 12 + 15
C	= 1000 x 4	= 4,000	= 30	= 45
D	= 1,500 x 6	= 9,000
		19,800*

Cost Statement under ABC

Particulars		A = 500	B = 800	C= 1,000	D = 1,500
Direct materials [Output × MCPU]		30,000	32,000	50,000	30,000
Direct labour [Output × DLH × $12]		18,000	48,000	36,000	90,000
Prime cost		48,000	80,000	86,000	120,000
Add: Overhead (based on ABC)
Machine expenses	[Machine hour × $5]	10,000	24,000	20,000	45,000
Schedule cost	[Production runs × $5,500]	27,500	38,500	44,000	55,000
Set up cost	[Production runs × $3,200]	16,000	22,400	25,600	32,000
Materials handling	[No. of materials handling × $3,060]	30,600	24,480	36,720	45,900
Total cost		$132,100	$189,380	$212,320	$297,900
Output		500	800	1,000	1,500
Cost per unit = Total cost ÷ Output		$264.20	$236.73	$212.32	$198.60

###########

Click on the link for YouTube videos
Accounting Equation	http://tiny.cc/c89jkz
Journal Entries in Nepali	http://tiny.cc/uaakkz
Journal Entries	http://tiny.cc/8aakkz
Journal Entry and Ledger	http://tiny.cc/caakkz
Ledger	http://tiny.cc/haakkz
Subsidiary Book	http://tiny.cc/399jkz
Cashbook	http://tiny.cc/889jkz
Trial Balance and Adjusted Trial Balance	http://tiny.cc/c59jkz
Bank Reconciliation Statement (BRS)	http://tiny.cc/q59jkz
Depreciation	http://tiny.cc/ugakkz

Click on the link for YouTube videos chapter wise
Financial Accounting and Analysis (All videos)	http://tiny.cc/jlersz
Accounting Process	http://tiny.cc/mlersz
Accounting for Long Lived Assets	http://tiny.cc/plersz
Analysis of Financial Statement	http://tiny.cc/slersz

###########

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

Details of three products and related information are given below by Maxwell Manufacturing Company on 31^st December:

Particulars	X	Y	Z
Volume in units	420	280	560
Direct materials cost per unit (MCPU)	50	60	30
Direct labour cost per unit (LCPU)	25	19	15
Machine hour per unit	5	4	3
Selling price per unit	430	400	300

Additional information:

a. The products are produced in similar process in a production run of 70 units each.

b. Requisition raised from the store for product X, Y and Z in 10, 15 and 20 respectively.

c. The numbers of order executed was in the batch of 20 units each totaling 63

The production overhead for the period was:

Items	Amount	Cost driver
Machine expenses	36,750	Machine hour
Set up cost	101,430	Production runs
Store receiving cost	78,520	Requisition raised
Quantity control	36,000	Production runs
Materials handling	97,650	Order executed

Required: (1) Conventional costing using machine hour and profit (loss)

(2) Cost driver rate; (3) ABC using suitable cost driver and profit (loss)

[Answer: (1) Total cost: X = $181,650; Y = $102,200; Z = 138,600;

Profit (Loss): X = ($1,050); Y = $9,800; Z = $29,400;

(2) CDR: $7.50; $5,635; $1,744.89; $2,000; $1,550;

(3) Total cost: X = $143,059; Y = $108,933; Z = 170,458;

Profit (Loss): X = $37,541; Y = $3,067; Z = ($2,458)]

SOLUTION:

Cost Statement under Conventional Costing

	X = 420	Y = 280	Z = 560
Direct materials [Output x MCPU]	21,000	16,800	16,800
Direct labour [Output x LCPU]	10,500	5,320	1,620
Prime cost	31,500	22,120	18,480
Add: Overhead (based on machine hour)
[Machine hour x Machine hour rate]	150,150	80,080	120,120
Total cost	$181,650	$102,200	$138,600
Sales = Output x SPPU	180,600	112,000	168,000
Profit (loss) = Sales – Total cost	($1,050)	$9,800	$29,400

Given and working note:

Machine hour	= Output x MHPU		Machine hour rate
X	= 420 x 5	= 2,100	= Total overhead ÷ Total MH
Y	= 280 x 4	= 1,120	= $350,350 ÷ 4,900 MH
Z	= 560 x 3	= 1,680	= $71.50
	Total MH	= 4,900*

Working note for cost driver rate:

Production runs = Output ÷ 70 units			Requisition raised	Order executed = Output ÷ 20 units
X	= 420 ÷ 70	= 6	= X + Y + Z	X	= 420 ÷ 20	= 21
Y	= 280 ÷ 70	= 4	= 10 + 15 + 20	Y	= 280 ÷ 20	= 14
Z	= 560 ÷ 70	= 8	= 45	Z	= 560 ÷ 20	= 28
		= 18				= 63

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Machine expenses	36,750	Machine hour	4,900	7.50
Set up cost	101,430	Production runs	18	5,635.00
Store receiving cost	78,520	Requisition raised	45	1,744.89
Quantity control	36,000	Production runs	18	2,000.00
Materials handling	97,650	Order executed	63	1,550.00

Cost Statement under ABC

Particulars		X = 420	Y = 280	Z = 560
Direct materials [Output × MCPU]		21,000	16,800	16,800
Direct labour [Output × LCPU]		10,500	5,320	1,620
Prime cost		31,500	22,120	18,480
Add: Overhead (based on ABC)
Machine expenses	[Machine hour × $7.50]	15,750	8,400	12,600
Set up cost	[Production runs × $5,635]	33,810	22,540	45,080
Store receiving cost	[Requisition raised × $1,744.89]	17,449	26,173	34,898
Quantity control	[Production runs × $2,000]	12,000	8,000	16,000
Materials handling	[Order executed × $1,550]	32,550	21,700	43,400
Total cost		$143,059	$108,933	$170,458
Sales = Output x SPPU		180,600	112,000	168,000
Profit (loss) = Sales – Total cost		$37,541	$3,067	($2,458)

Click on the photo for FREE eBooks

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2E

Details of three products and related information are given below by ABC Manufacturing Company on 31^st December:

Particulars	A	B	C
Production units	2,000	1,000	1,000
Direct materials ($per kg)	20	10	30
Direct labour (minute per unit)	15	30	60
Batches of materials	5	6	9
Machine hours per unit	0.50	0.40	0.25

Materials dispatch (in 100 units pack each)

Wage rate per hour $20

Direct expenses is 50% of direct labour

Overhead rate $25.50 per hour based on labour hours

Cost and cost drivers:

Cost items	Cost drivers	% of total overhead
Materials receipt and inspection	No. of batches	40%
Process power	Machine hours	25%
Materials handling	No. of materials dispatch	35%

Required:

(a) Total overhead and apportionment of overhead; (c) Total cost and cost per unit under volume based costing

[Answer: (a) Total overhead $51,000 and $20,400; $12,750; $17,850;

(b) Total cost: A = $66,250; B = $46,250; C = $72,500;

CPU: A = $33.13; B = $46.25; C = $72.50;

(c) CDR: $1,020; $7.727; $446.25;

(d) Total cost: A = $76,752; B = $48,674; C = $65,574;

CPU: A = $38.38; B = $48.67; C = $65.57]

SOLUTION:

Labour hours	= Output x LHPU
A	= 2,000 x 15/60	=	500
B	= 1,000 x 30/60	=	500
C	= 1,000 x 60/60	=	1,000
			2,000 hours

Total overhead

Labour hour rate	=	Total overhead ÷ Total labour hours
25.50	=	Total overhead ÷ 2,000 hours
25.50 × 2,000	=	Total overhead
Total overhead	=	$51,000

Apportionment of overhead

Materials receipt and inspection	= $51,000 @ 40%	= 20,400
Process power	= $51,000 @ 25%	= 12,750
Materials handling	= $51,000 @ 35%	= 17,850
		$51,000

Cost Statement under Conventional Costing

Particulars ↓ Output ®		A = 2,000	B = 1,000	C = 1,000
Direct materials	[Output x MCPU]	40,000	20,000	20,000
Direct labour	[Output x LCPU x $20]	10,000	10,000	20,000
Direct expenses	[50% of direct labour]	5,000	5,000	10,000
Prime cost		55,000	35,000	50,000
Add: Overhead (based on labour hour)
[Labour hours x $22.50]		11,250	11,250	22,500
Total cost		66,250	46,250	72,500
Output		2,000	1,000	1,000
Cost per unit = Total cost ÷ Output		33.13	46.25	72.50

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Materials receipt	20,400	No. of batches	20	1,020.000
Process power	12,750	Machine hours	1,650	7.727
Materials handling	17,850	No. of materials dispatch	40	446.250

Working note for total cost driver

No. of batches

= A + B + C

= 5 + 6 + 9

= 20

Machine hours = Output x MHPU				No. of dispatches = Output ÷ 100 units
A	= 2,000 x 0.50	=	1,000	A	= 2,000 ÷ 100	= 20
B	= 1,000 x 0.40	=	400	B	= 1,000 ÷ 100	= 10
C	1,000 x 0.25	=	250	C	= 1,000 ÷ 100	= 10
			1,650 hours			= 40

Cost Statement under Activity Based Costing

Particulars ↓ Output ®		A = 2,000	B = 1,000	C = 1,000
Direct materials	[Output × MCPU]	40,000	20,000	20,000
Direct labour	[Output × LCPU × $20]	10,000	10,000	20,000
Direct expenses	[50% of direct labour]	5,000	5,000	10,000
Prime cost		55,000	35,000	50,000
Add: Overhead (based on ABC)
Materials R & I	[No. of batches × $1,020]	5,100	6,120	9,180
Process power	[Machine hours × $7.727]	7,727	3,091	1,932
Materials handling	[No. of dispatches × $446.25]	8,925	4,463	4,462
Total cost		76,752	48,674	65,574
Output		2,000	1,000	1,000
Cost per unit = Total cost ÷ Output		38.38	48.67	65.57

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2F

Usha Components (P) Ltd has following data on 31^st December:

Particulars ↓ Products ®	X	Y	Z
Output in units	2,000	1,500	800
Direct materials per unit in $	10	6	12
Direct labour per unit in minute	24	40	60

Wage rate per hour $24.

Other information:

Particulars ↓	X	Y	Z
No. of materials batches	10	15	10
Machine hours per unit	6	3	2
Quantity of materials handling in units	8,000	9,000	2,400

Cost and cost drivers:

Cost items	Cost drivers	Amount
Materials receipt and inspection	No. of batches	32,410
Process power	Machine hours	30,770
Materials handling	Quantity of materials handling	25,220

Required: (1) Cost statement under traditional costing showing total cost and cost per unit.

(2) Cost statement under ABC showing total cost and cost per unit.

(3) Change cost per unit based on traditional costing.

[Answers:

		A	B	C
1	Total cost	66,400	67,000	56,000
1	CPU	33.20	44.67	70.00
2	Total cost	79,260	66,240	43,900
2	CPU	39.63	44.16	54.88
3	% change	19.367%	1.142%	21.60%

SOLUTION:

Given and working note:

DLH	= Output × Minute ÷ 60			Labour hours rate
X	= 2,000 × 24 ÷ 60	=	800	= Total overhead ÷ Total labour hours
Y	= 1,500 × 40 ÷ 60	=	1,000	= $88,400 ÷ 2,600 hours
Z	= 800 × 60 ÷ 60	=	800	= $34
			2,600

Cost Statement under Traditional Costing

Particulars	Products
	X = 2,000	Y= 1,500	Z = 800
Direct materials [Output × RMPU]	20,000	9,000	9,600
Direct labour [DLH × $24]	19,200	24,000	19,200
Prime cost	39,200	33,000	28,800
Add: Overhead (based on labour hour):
Labour expenses DLH × Labour hour rate)	27,200	34,000	27,200
Total cost	$66,400	$67,000	$56,000
Output	2,000	1,500	800
Cost per units = Total cost ÷ Output	$33.20	$44.67	$70.00

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Materials receipt and inspection	32,410	No. of batch	35	926.00
Process power	30,770	Machine hours	18,100	1.70
Materials handling	25,220	Quantity of materials	19,400	1.30

Working note for total cost driver

No. of batch	Process power = Output × MH			Quantity of materials
X = 10	X = 2,000 × 6	=	12,000	X = 8,000
Y = 15	Y = 1,500 × 3	=	,500	Y = 9,000
Z = 10	Z = 800 × 2	=	1,600	Z = 2,400
35			18,100	19,400

Cost Statement under Activity Based Cost (ABC)

Particulars		Products
		X = 2,000	Y = 1,500	Z = 800
Direct materials [Output × RMPU]		20,000	9,000	9,600
Direct labour [DLH × $12]		19,200	24,000	19,200
Prime cost		39,200	33,000	28,800
Add: Overhead (based on ABC):
Materials receipt and inspection	[No. of batch × $926]	9,260	13,890	9,260
Process power	[Machine hours × $1.70]	20,400	7,650	2,720
Materials handling	[Qty. of materials × $1.30]	10,400	11,700	3,120
Total cost		$79,260	$66,240	$43,900
Output		2,000	1,500	800
Cost per units = Total cost ÷ Output		$39.63	$44.16	$54.88

Percentage change based on Traditional Costing

Particulars	X	Y	Z
Cost per unit as per traditional costing	33.20	44.67	70.00
Cost per unit as per ABC	39.63	44.16	54.88
Change or different	6.43	0.51	15.12
% change based on traditional costing =(change ÷ traditional costing) × 100	19.367%	1.142%	21.60%

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2G

Ekta Copy Industries manufactures different sizes of diaries. The following data is related to four brands diaries on first week of January (amount in $/₹/Rs):

Particulars	A	B	C	D
Output in units	500	5,000	600	7,000
Paper cost per unit (direct materials)	$5	$5	$16	$17
DLH per unit	0.5	0.5	2	1.5
Machine hours per unit	0.25	0.25	1	1.5
Labour cost per unit	$6	$6	$6	$6

Total production overhead by account department as under (amount in $/₹/Rs):

Machine expenses	37,425
Set up cost	4,250
Materials ordering cost	1,920
Materials handling cost	10,260
Production runs	8,520

Cost driver activities:

Activities	A	B	C	D
No of set up	1	6	2	8
No. of materials order	1	4	1	4
No. of materials handling	2	10	3	12
No. of production runs	2	5	1	4

Required: (1) Total cost, cost per unit under Conventional Costing System based machine hours

(2) Cost driver rate; (3) Total cost, cost per unit under Activity Based Costing.

[Answers:

		A	B	C	D
1	Total cost	4,625	46,250	19,800	234,500
1	CPU	9.25	9.25	33.00	33.50
2	CDR	$3; $250; $192; $380; $710
3	Total cost	6,997	53,368	21,142	223,668
3	CPU	13.99	10.67	35.24	31.95

SOLUTION:

Given and working note:

Machine hour = Output × MHPU			Machine hours rate
A	= 500 × 0.25	= 125	= Total overhead ÷ Total MH
B	= 5,000 × 0.25	= 1,250	= $62,375 ÷ 12,475 hours
C	= 600 × 1.00	= 600	= $5
D	= 7,000 × 1.50	= 10,500
		12,475

Cost Statement under Conventional Costing System

Particulars	Products
	A = 500	B = 5,000	C = 600	D = 7,000
Direct materials [Output × MCPU]	2,500	25,000	9,600	119,000
Direct labour [Output × DLHPU × $6]	1,500	15,000	7,200	63,000
Prime cost	4,000	40,000	16,800	182,000
Add: Overhead (based on machine hour):
Machine expenses (MH × Machine hour rate)	625	6,250	3,000	52,500
Total cost	$4,625	$46,250	$19,800	$234,500
Output	500	5,000	600	7,000
Cost per units = Total cost ÷ Output	$9.25	$9.25	$33.00	$33.50

Calculation of Cost Driver Rate

Activities	Amount	Cost Driver (CD)	Total CD	CD Rate
1	2	3	4	5 = 2 ÷ 4
Machine oriented	37,425	Machine hours	12,475	3
Set up	4,250	No. of set up	17	250
Materials ordering	1,920	No. of materials order	10	192
Materials handling	10,260	No. of materials handling	27	380
Production runs	8,520	No. of production	12	710

Working note for total cost driver

No. of set up	= A+B+C+D	= 1+6+2+8	= 17
No. of materials order	= A+B+C+D	= 1+4+1+4	= 10
No. of materials handling	= A+B+C+D	= 2+10+3+12	= 27
No. of production	= A+B+C+D	= 2+5+1+4	= 12

Cost Statement under Activity Based Cost (ABC)

Particulars		Products
		A= 500	B =5,000	C =600	D= 7,000
Direct materials [Output × MCPU]		2,500	25,000	9,600	119,000
Direct labour [Output × DLHPU × $6]		1,500	15,000	7,200	63,000
Prime cost		4,000	40,000	16,800	182,000
Add: Overhead (based on ABC):
Machine oriented	[Machine hours × $3]	375	3,750	1,800	31,500
Set up	[No. of set up × $250]	250	1,500	500	2,000
Materials ordering	[No. of order × $192]	192	768	192	768
Materials handling	[No. of materials handling × $380]	760	3,800	1,140	4,560
Production runs	[No. of production runs × $710]	1,420	3,550	710	2,840
Total cost		$6,997	$53,368	$21,142	$223,668
Output		500	5,000	600	7,000
Cost per units = Total cost ÷ Output		$13.99	$10.67	$35.24	$31.95

#####

Problems and Answers of Activity Based Costing

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

ABC Company (P) Ltd has following information:

Particulars $ Products ®	P1	P2	The activity costs are:
Output in units	1,000	10,000	Volume related	$110,000
Machine hour per unit	2	2	Purchase related	$120,000
DLH per unit	4	4	Set up related	$210,000
No. of purchase order	80	160	Total	$440,000
No. of set ups	40	60

Required: (a) Cost driver rate; (b) Total overhead under ABC;

[Answer: (1) $5; $500 and $2,100;

(2) $134,000 and $306,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

Kohinoor Metal Uddhyog manufactures different kind of auto accessories. The following data are related to four specific products:

Particulars	A	B	C	D
Output in units	500	800	1,000	1,500
Prime cost	$48,000	$80,000	$86,000	$120,000
Machine hour per unit	4	6	4	6
No. of production runs	5	7	8	10
No. of dispatch	10	8	12	15

Further information:

Short term variable cost:	Machine production	$99,000	Machine hour
Long term variable cost:	Schedule cost	$165,000	Production runs
	Set up cost	$96,000	Production runs
	Dispatch of goods	$137,700	No. of dispatch

Required: (1) Cost driver rate; (2) Total overhead under activity based costing; (3) Cost per unit under ABC

[Answer: (1) $5; $5,500; $3,200 and $3,060;

(2) $132,100; $189,360; $212,320 and $297,900;

(3) $264.20; $236.73; $212.32 and $198.60]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

Birat Shoes Company has got order for three sizes shoes. Other information is:

Particulars $	Products ®	M	N	O
Output units		420	280	560
Standard usage of raw materials		2	4	3
Materials cost per unit	(in $)	$25	$15	$10
DLH per unit		2.5	2.0	1.5
Machine hour per unit	(hours)	5	4	3
Selling price per unit	(in $)	$430	$400	$300
Production runs		6	4	8
Order executed		21	14	28
Requisition raised		10	15	20

DLH $10 per labour hour

Cost driver and expenses:

	Amount	Cost driver
Volume related cost	36,750	Machine hour
Set up cost	101,430	No. of production runs
Store receiving cost	79,785	No. of requisition raised
Quantity control cost	36,000	No. of production runs
Materials handling and dispatch	97,650	No. of order executive
	$351,615

Required: (a) Total cost and cost per unit under conventional costing based on labour hour rate

(b) Cost driver rate; (c) Total cost and cost per unit under ABC

[Answer: (a) M = $182,196 and $433.80;

N = $102,771 and $367.04; O = $145,757 and $260.28;

(b) $7.5; $5,635; $1,773; $2,000 and $1,550;

(c) M = $143,340 and $341.29; N = $109,635 and $391.55;

O = $177,740 and $317.39]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

AP Manufacturing Company has a single production process. Three products P, Q and Rare produced by workers the wage rate per hour is $4. The budget information has been obtained for the year is as follows:

Product	Production units	Material	Materials cost	Labour hours	Machine hours	Batches
		Per unit	Per unit	Per unit	Per unit
P	2,000	2 units	$3	0.50 hour	1.00 hour	6
Q	1,000	3 units	$5	0.25 hour	0.25 hour	5
R	500	4 units	$2	1.00 hour	1.50 hour	4

The overhead cost and related cost drives are:

Overhead	Cost Drives	Amount (in $)
Material receipt and inspections	No of batches	30,000
Material handing	Quantity of materials	18,000
Short term variable cost	No of machine hours	6,000

Required: Using activity based costing find out: (1) Cost driver rate; (2) Total cost for each product; (3) Cost per unit

Answers: (1) CDR = $2,000; $2; $2;

(2) Total cost = $34,000; $22,500; $16,500;

(3) $17; $22.50; $33]

Materials per unit is applied for Quantity not for direct materials

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2E

ABC Company manufactures two products namely X and Y. Data for the period is as follows:

	Product X	Product Y
Output in units	2,000	3,000
Machine hour unit	2 hours	1 hour
Labour hour per unit	2 hours	3 hours
Production run	7	3

Total production overhead recorded and cost-driver fixed by cost accounting department is analyzed as:

Cost	Cost Drives	Amount ($)
Set up cost	Production runs	20,000
Machine department	Machine hours	14,000
Scheduling cost	Production runs	18,000

Required: (a) Total overhead and overhead rate by using labour hour rate; (b) Cost driver rate

Answer: (1) Total overhead: X = $16,000; Y = $36,000;

ORPU: X = $8.00, Y= $12.00;

(2) Total overhead: X = $34,600; Y = $17,400;

ORPU: X = $17.30, Y = $5.80;

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2F

A Company produces two types of products. The president of the company recently decided to change from a volume based costing system to an activity based cost system. To assess the effect of the change, the following data have been gathered:

Products

Units

Machine hours

Production runs

Prime cost

Material component

3,000

2,000

9,000

4,000

10,000

8,000

6,000

8,000

Total

5,000

13,000

18,000

14,000

The overhead cost and cost drives are as follows:

Cost	Cost drives	Amount ($)
Machine related activities	Machine hours	39,000
Set up cost	Production runs	30,000
Material handling costs	No. of material components	28,000