Activity Based Costing | Traditional Costing System | Conventional Costing

 

 

Concept of Costing

Traditional costing system is the oldest system of calculating total production cost and cost per unit.

Under this concept overhead are allocated only production base.

This allocation is done on the basis of labour hour or machine hours only.

 

As well as demand of production increased, production capacity also increased.

Goods are produced in large quantity by manufacturing companies.

Direct materials and direct labour are easy to handle but indirect materials, indirect labour and indirect expenses becomes difficult to handle.

 

Nowadays many organizations have adopted advance manufacturing technology. 

Direct costs are becoming smaller portion of total cost but indirect expenses are increasing enormously or extremely.

Tradition costing system charges indirect overhead or expenses on labour hour or machine hour basis that is not relevant in modern or advance manufacturing technology. 

 

Definition of Activity Based Costing

According to CIMA, “ABC contribution to cost unit on the basis of benefit received from indirect activities e. g. ordering, setting up, and assuring quality.”

 

 

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Traditional Costing System | Conventional Costing

[Conventional costing system, absorption costing system, volume based costing system]

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.

 

Cost Statement under Traditional Costing

Particulars	Products
	P	Q	R
Direct materials      [Output x Usage x RMPU]	xxxx	xxxx	xxxx
Direct labour           [Output x LHPU x Rs]	xxxx	xxxx	xxxx
Prime cost	xxxx	xxxx	xxxx
Add: Overhead (based on machine or labour hours):
Machine or Labour  expenses (Hours  x  rate)	xxxx	xxxx	xxxx
Total cost	$xxxx	$xxxx	$xxxx
Output	xxxx	xxxx	xxxx
Cost per units          = Total cost ÷ Output	$xxxx	$xxxx	$xxxx

 

Where:

RMPU = raw materials per unit

LHPU = labour hours per unit

 

 

Limitation of Traditional Costing

Following are the main limitations of trading costing:

(a) This system follows only single cost driver as labour hour or machine hour.

(b) It focuses quantity not activity.

(c) It is suitable for only small industry that produces narrow range of products.

(d) It is based on only unit basis, there are other expenses that are not related to units like materials handling, set-up cost, production schedule, inspection etc.

 

 

 

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

PROBLEM: 1A

The following information is provided to you (amount in $/₹/Rs):

Products	Output in units	DLH (per unit)	Materials cost per unit (MCPU)
A	20,000	0.40	$5
B	10,000	0.50	$4

Wage rate per hour $10

Additional information:

Repair cost	$20,000
Set up cost	$30,000

Required: (a) Value of materials; (b) Total DLH; (c) Labour hour rate; (d) Total labour cost; (e) Income statement

[Answer: (a) $100,000 and $40,000; (b) 13,000 hours; (c) $3.85;

(d) $30,800 and $19,250; (e) Total cost $210,800 and $109,250;

CPU $10.54 and $10.932]

SOLUTION:

Value of materials  

Value of materials	= Output x MCPU
A	= 20,000 units x $5	= $100,000
B	= 10,000 units x $4	= $40,000

 

Total direct labour hours

Total DLH	= Output x DLH
A	= 20,000 units x 0.40	= 8,000 hours
B	= 10,000 units x R0.50	= 5,000 hours
		= 13,000 DLH

 

Labour hour rate (LHR)

= Total overhead ÷ Total DLH

= ($20,000 + $30,000) ÷ 13,000 DLH

= 50,000 ÷ 13,000

= $3.85

 

 

Total labour cost

Value of labour cost	= DLH × LHR
A	= 8,000 DHL × $3.85	= $30,800
B	= 5,000 DLH × $3.85	= $19,250

 

Cost Statement under Traditional Costing

Particulars	Products
	A = 20,000	B = 10,000
Direct materials [Output x MCPU]	100,000	40,000
Direct labour      [Output x DLH x $10]	80,000	50,000
Prime cost	180,000	90,000
Add: Overhead (based on labour hour):
Labour expenses (DLH x LHR)	30,800	19,250
Total cost	$210,800	$109,250
Output	20,000	10,000
Cost per unit = Total cost ÷ Output	$10.54	$10.93

 

 

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

PROBLEM: 1B

Square Engineering Workshop produces three products using same production methods. Following information is given to you (amount in $/₹/Rs):

Department  ®	P	Q	R
Output (units)	500	1,000	2,000
Raw materials usage (units)	3	2	1
Raw materials cost per unit ($)	5	4	10
Machine hour per unit (hour)	0.5	1	0.5

 

Other information (amount in $/₹/Rs):

Set up cost	Materials handling	Production requisition	Total overhead
15,000	20,000	2,750	37,750

Required: (1) Total cost under traditional costing; (2) Cost per unit

[Answer: (1) $15,750; $43,000 and $45,000;

 (2) $31.50; $43.00 and $22.50]

SOLUTION:

Given and working note:

Machine hours	= Output x MHPU		Machine  hours rate (MHR)
P1	=   500 x 0.5	=    250	= Total overhead ÷ Total Machine  hours
P2	= 1,000 x 1.0	= 1,000	= $37,750 ÷ 2,250 hours
P3	= 2,000 x 0.5	= 1,000	= $15
		= 2,250

 

Cost Statement under Traditional Costing

Particulars	Products
	P = 500	Q = 1,000	R = 2,000
Direct materials      [Output x Usage x RMPU]	7,500	8,000	20,000
Direct labour           [Output x LHPU x $10]	5,000	20,000	10,000
Prime cost	12,000	28,000	30,000
Add: Overhead (based on machine hours):
Machine expenses (MH x MHR)	3,750	15,000	15,000
Total cost	$15,750	$43,000	$45,000
Output	500	1,000	2,000
Cost per units  = Total cost ÷ Output	$31.50	$43.00	$22.50

 

Keep in Mind (KIM)

There are two methods for traditional costing system:

·          Overhead based on labour hour

·          Overhead based on machine hours

 

 

 

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Problems  and  Answers  of  Traditional Costing under Activity Based Cost

 

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

PROBLEM: 1A

SM Handicraft Center manufactures handcrafted goods. Following information is available for three different products:

Particulars $	Products ®	O	P	Q
Output	in units	1,000	2,000	7,000
Materials cost per unit (MCPU)	in $	8	12	16
Labour cost per unit      (LCPU)	in $	12	15	18
Machine hour per unit (MHPU)	in hour	4	4	4

Other information:

Materials related cost $88,000

Production run cost $100,000

Customer’s order execution $112,000

Required: (for three products)

(a) Direct materials cost; (b) Direct labour cost; (c) Total machine hour; (d) Total machine hour cost;

(e) Income statement under traditional costing; (f) Cost per unit

[Answer: (a) $8,000; $24,000 and $112,000;

(b) $12,000; $30,000 and $126,000;

(c) 4,000 hours; 8,000 hours and 28,000 hours; (d) MHR = $7.5;

(e) Total cost $50,000; $114,000 and $448,000;

(f) CPU: O = $50; P = $57 and Q = $64]

 

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

PROBLEM: 1B 

Hi-life Polymers (P) Ltd manufactures slippers Following data are related to three different brands slippers:

Brands	Output units	Materials usage per unit	Materials cost per unit (MCPU)	DLH per unit
X	25,000	1.5	$10.00	1.0
Y	20,000	2.5	$8.00	2.0
Z	30,000	2.0	$12.5	1.5

Direct wages rate per hour $15

Actual overhead incurred:

Materials handling cost	$50,000
Indirect labour	$160,000
Repairs and maintenance	$100,000
	$310,000

Required: (a) Value of materials; (b) Total DLH; (c) Total labour cost; (d) Income statement under traditional costing;

(e) Cost per unit

[Answer:  (a) $375,000; $400,000 and $750,000;

(b) 25,000 hours; 40,000 hours and 45,000 hours; (c) LHR = $2.82

(d) Total cost $820,500; $11,12,800 and $15,51,900;

(e) CPU: X = $32.82; Y = $55.64 and Z = $51.73]

 

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