Post on 15-Mar-2018
CA Final, Paper 5, Advanced management Accounting, Chapter 1 Developments in Business Environment :Part 2
CA. Anurag Singal B.Com(H), ACA.
Activity Based Costing
Activity Based Management
Activity Based Budgeting
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Increasing • Overhead costs
Increasing • Market
competition
Increasing • Product diversity
Decreasing • Costs of
information processing
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It then assigns the costs of these activities only to the products that are actually demanding the activities.
ABC first assigns costs to the activities that are the real cause of the overhead.
Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than traditional approach of simply allocating costs on the basis of machine hours.
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• An event that incurs cost. Activity
• An item for which cost measurement is required, i.e. a product or service. Cost object
• Any factor or activity that causes a change in the cost of an activity. Cost driver
• Measure of the quantity of resources consumed by an activity. Resource cost driver
• Measure of frequency and intensity of demand, placed on activities by cost objects. Activity cost driver
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In order to understand how ABC operates, it is important to know the meaning of few terms:
• No. of research projects • Personnel hours on a project.
Research & Development
• No. of products in design • No. of parts per product
Design of product & services
• No. of service calls • No. of products serviced Customer service
• No. of ads, sales personnel • Sales revenue Marketing
• No. of units distributed • No. of customers Distribution
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Business function Cost driver
Identify Resources
Identify Activities
Identify Cost Objects
Define Resource
Drivers
Define Activity Drivers
Enter Resource
Costs
Enter Resource Driver Qty
Enter Activity Driver Qty.
Calculate Costs
Facility level Activities
Product level Activities
Batch level Activities
Unit level Activities
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ABC Absorption Costing
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Relation of OH Overheads related to activities
Overheads related to cost centres/departments
Realistic More realistic Not realistic of cost behaviour
Cost hours Activity wise cost hours determined
Time is the only cost driver
Assignment Costs assigned to cost objects, i.e., customers, products, services, etc.
Costs assigned to cost units, i.e., products, job or hours.
More accurate costing
Better understanding of overhead
Utilizes unit cost rather than just total cost
Integrates well with Six sigma
Enables costing of processes, supply chains and value streams
Facilitates benchmarking
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Staff Training Process specification
Activity definition
Activity driver selection Costing
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ABC is a complement to TQM
Wholesale distributors gain significantly through ABC
ABC also assists in facility and resource expansion
ABC provides huge decision support for human resources
Enables pricing where cost plus markup is followed
Facilitates make /buy decisions, transfer pricing, capital investment, etc
A procedure for analysing the processes of a business to identify strengths and weaknesses.
It seeks out areas where a business is losing money so that these activities are either eliminated or improved to increase profitability.
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The process includes the following analysis:
Cost driver analysis
Activity analysis
Performance analysis
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• This process identifies the factors that cause activities to be performed.
• This in turn helps to manage activity costs.
Cost driver Analysis
• This process identifies the activities and the activity centers of an organization
• Also identifies the Value Added and Non-Value Added activities.
Activity Analysis
• This process involves the identification of appropriate measures to report the performance of activity centers.
Performance Analysis
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• Activities indispensable to complete a process
• Eg., Polishing of furniture by a furniture manufacturer
Value-Added Activities (VA)
• Activities which do not improve the quality or function of a product.
• Eg., Moving materials or machine set up for a production run.
Non-Value-Added
Activities (NVA)
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Provision of focus for cost reduction
Provides a clear view of how to implement an ABB.
Provides understanding of underlying causes of business processing costs.
Provision of excellent basis for effectiveness of management decision making
Identification of key process waste elements, permit management prioritization and leverage of key resources.
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Cost Reduction
Activity based Budgeting
Business Process Re-engineering
Benchmarking
Performance Measurement
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Technique used to determine the cost of activities and the final output
ABC Management philosophy that focuses on planning, execution and measurement of activities
ABM
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It is a process of planning and controlling the expected activities for the organisation to derive a cost effective budget that meets forecast workload and agreed strategic goals.
It analyses the products/services to be produced, what activities are required to produce those products /services and finally what resources need to be budgeted to perform these activities.
Simply, ABB is the reversing of the ABC process.
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By implementing ABC, CCEB was able to calculate costs in a fair and transparent way so that the sales force is charged correctly according to complexity that the Supply Chain had to deal
with.
CCEB wanted to use the information from ABC analysis to formulate:
Cost/ Profit Modeling Performance modeling Set-up an internal recharge mechanism to sales.
This was a challenge to which CCEB needed answers to stay on track to achieve growth and other objectives.
Coca Cola Enterprises Belgium (CCEB) was confronted with an increasing Cost to Serve (CTS) due to changing customer landscape.
All these actions helped in reducing their Cost to Serve and still be in line with the new Corporate Sales & Marketing strategy.
After implementing ABC, multiple initiatives were derived that ultimately led to redesign of the regional distribution strategy including: - Optimizing efficiency and capacity - Designing the most efficient process - Implementing the best practice processes in distribution centers.
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Q) A manufacturing company produces ball pens that are printed with the logos of various companies. Each pen is priced at Rs.5. Costs are as follows:
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Cost driver Unit variable cost (Rs.) Level of cost driver
Other data: Total fixed costs (conventional) - Rs.48,000 Total fixed costs (ABC) - Rs.36,500 Required: (i)Compute the break even point in units using ABC analysis (ii)Suppose the Company could reduce the set up cost by Rs.75 per set up and could reduce the number of engineering hours needed to 215. How many units must be sold to break even in this cost.
Units sold 2.5 -
Set up 225 40
Engineering hours 10 250
1. Break-even units = [Fixed costs + (Setup costs X Set ups) +(Engg. cost X Engg. hrs)] (Sale price – Variable cost) = 36,500 + (Rs.225 X 40) +(Rs.10 X 250) Rs.5 – Rs.2.5 = 19,200 units 2. New cost = 36,500 + (Rs.150 X 40) + (Rs.10 X 215) = 36,500 + 6,000 + 2,150 = Rs. 44,650 New Break even point = 44,650/(Rs.5 – Rs.2.5) = 17,860 units
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A Company produces 3 products A, B and C for which the standard costs and quantities per unit are as follows:
Production overhead split by departments – Department 1 = Rs.11,00,000 Department 2 = Rs.15,00,000
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Products A B C
Quantity produced Direct material/p.u.(Rs.) Direct labour/p.u. (Rs.) Labour hrs/p.u. Machine hrs/p.u. No. of purchase requisitions No. of set ups
10,000 50 30 3 4
1200 240
20,000 40 40 4 4
1800 260
30,000 30 50 5 7
2,000 300
Contd.
Department 1 is labour intensive and Department 2 is machine intensive.
Total labour hours in Dept 1 = 183,333 Total machine hours in Dept 2 = 5,00,000 Production Overhead split by activity: -Receiving/inspecting Rs.14,00,000 -Production scheduling/machine set up Rs.12,00,000 Rs.26,00,000 No. of batches received/inspected = 5000 No. of batches for scheduling & set up = 800 Prepare Product Cost statement under Traditional Absorption
Costing and Activity Based Costing method
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i) Traditional Absorption Costing Absorption rates: Dept 1 = Rs.11,00,000 = Rs.6 per labour hr 183,333 hrs Dept 2 = Rs15,00,000 = Rs.3 per machine hr 5,00,000 hrs
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Contd.
Products A B C
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Product Cost Statement
Contd.
Direct Material Direct Labour
50 30
40 40
30 50
Overhead: Department 1
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(3 hrs X Rs.6)
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(4 hrs X Rs.6)
30
(5 hrs X Rs.6)
Overhead: Department 2
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(4 hrs X Rs.3)
12
(4 hrs X Rs.3)
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(7 hrs X Rs.3)
Total cost p.u. 110 116 131
ii) Activity Based Costing Cost driver rates: Receiving/Inspecting = Rs.14,00,000 5000 (no. of batches recd) = Rs.280 per requisition Production Scheduling = Rs.1500 per set up
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Contd.
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Products A B C
Contd.
Direct Material Direct Labour
50 30
40 40
30 50
Overhead: Receiving
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(Rs.280X1200) / 10,000 units
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(Rs.280X1800)/ 20,000 units
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(Rs.280X2000) / 30,000 units
Overhead: Production Scheduling
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(Rs.1500X240) / 10,000 units
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(Rs.1500X260) / 20,000 units
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(Rs.1500X300) / 30,000 units
Total cost p.u. 150 125 114
A B C
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Traditional System 110 116 131
ABC 150
125 114
Difference (40) (9) 17
Biscuit Ltd. Manufactures 3 types of biscuits, A, B and C, in a fully mechanised factory. The company has been following conventional method of costing and wishes to shift to Activity Based Costing System and therefore wishes to have the following data presented under both the systems for the month.
Inspection cost Rs p.m. 73,000 Machine – Repairs & Maintenance Rs p.m. 1,42,000 Dye cost Rs p.m. 10,250 Selling overheads Rs p.m. 1,62,000
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A B C
Prime cost (Rs per unit) 12 9 8
Selling price (Rs per unit) 18 14 12
Gross production (units/prodn run) 2,520 2,810 3,010
No. of defective units / production run 20 10 10
Inspection: C
No. of hours / production run 3 4 4
Dye cost / production run (Rs.) 200 300 250
No. of machine hours / production run 20 12 30
Sales – No. of units / month 25,000 56,000 27,000
35 Contd.
The following additional information is given: i. No accumulation of inventory is considered. All good units produced
are sold. ii. All manufacturing and selling overheads are conventionally allocated
on the basis of units sold. iii. Product A needs no advertisement. Due to its nutritive value, it is
readily consumed by diabetic patients of a hospital. Advertisement costs included in the total selling overhead is `83,000.
iv. Product B needs to be specially packed before being sold, so that it meets competition. `54,000 was the amount spent for the month in specially packing B, and this has been included in the total selling overhead cost given.
36 Contd.
You are required to present product-wise profitability of statements under the conventional system and the ABC system and accordingly rank the products
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A B C Total
Sales Units 25,000 56,000 27,000 1,08,000
Selling price/unit 18 14 12
Sales Value (A) 4,50,000 7,84,000 3,24,000 15,58,000
Prime Cost Overhead /unit 12 9 8
No. of units/run 2,520 2,810 3,010
Prime Cost (B) 3,02,400 5,05,800 2,16,720
Gross Margin (A-B) 1,47,600 2,78,200 1,07,280 5,33,080
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Total A B C
Inspection Cost 73,000/146* 30/80/36 respectively
73,000 15,000 40,000 18,000
Machine Maintenance 1,42,000/710* 200/240/270 respectively
1,42,000 40,000 48,000 54,000
Dye Cost 10,250 2,000 6,000 2,250
Sub Total 2,25,250 57,000 94,000 74,250
Selling Overhead Advertisement
83,000/( 56,000+27,000) *56/27respectively
83,000 - 56,000 27,000
Other Overheads
25,000/108 * 25/56/27 respectively
25,000 5,787 12,963 6,250
Packing _______ _____ 54,000 _______
Sub Total Selling Overhead 1,62,000 5,787 1,22,963 33,250
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A B C Total
Good Units /production run (1) 2,500 2,800 3,000
Defectives/production run (2) 20 10 10
Gross Production per Run (3=1+2) 2,520 2,810 3,010
Sales (Good Units) (4) 25,000 56,000 27,000
No of Runs (5= 4/1) 10 20 9 Gross Production (6=3*5) 25,200 56,200 27,090
Prime Cost/Unit (7) 12 9 8
Prime Cost (8=6*7) 302,400 505,800 216,720 10,24,920
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Sl No A B C Total
No of Production runs (1) 10 20 9
Inspection Hours/run (2) 3 4 4
Inspection Hours (1*2) 30 80 36 146
Machine Hours/run (3) 20 12 30
Machine Hours (1*3) 200 240 270 710
Dye Costs/run (4) 200 300 250
Dye Cost (1*4) 2,000 6,000 2,250 10,250
41 Contd.
Conventional Accounting System
Total A B C
Sales – units / Production (good units)
1,08,000 25,000 56,000 27,000
Gross Margin ( Rs) 5,33,080 1,47,600 2,78,200 1,07,280
Production overheads (Rs) (apportioned on the basis of number of units)
2,25,250 52,141 1,16,797 56,313
Selling Overhead (Rs) (apportioned on the basis of number of units)
1,62,000 37,500 84,000 40,500
Sub-Total Overhead (Rs) 3,87,250 89,641 2,00,797 96,813
Net profit (Rs) 1,45,830 57,959 77,403 10,467
Ranking II I III
42 Contd.
Activity Based System
A B C
Sales – units / Production (good units) 25,000 56,000 27,000
Gross Margin (Rs) 1,47,600 2,78,200 1,07,280
Production overheads (Rs) 57,000 94,000 74,250
Selling Overhead (Rs) 5,787 1,22,963 33,250
Sub total Overhead (Rs) 62,787 2,16,963 1,07,500
Net profit (Rs) 84,813 61,237 (220)
Ranking I II III
Activity Based Costing
Activity Based Management
Activity Based Budgeting
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