Group members

Vaibhav Nagwanshi-065 Divya Radhakrishnan-074 Revanth Prakash-078 Dharmendar tanwar-100 Sreejith K.T.-102 Ravi Charbathia-114

We share it all..
Inky, Pinky, and Ponky order separate items for lunch. Inkys order amounts to Pinky consumed Ponkys order is Total $14 $30 $16 $60

What is the average cost per lunch?

We shared it thus..
$60 3 = $20

Inky and Ponky are over-costed.

Pinky is Under-costed.

Todays businesses are working in an increasingly complex environment.

Use of Advanced Technology

Product Life Cycle Product Complexity Channels of Distribution

Quality Requirements
Product Diversity

Indirect Cost
Not easily and conveniently traceable to cost objects
Cost element is shared among cost objects Physically impossible to trace

Not cost effective to trace

Traditional Overhead Allocation

Assumes all overhead is volume-related Factory-wide or departmental rates All related to single activity measure Job Order = Direct Labor Costs Process Cost = Machine Hours Departmental focus, not process focus Focus on costs incurred, not cause of costs

Activity-Based Costing

Traditional allocation method

Costs Products

Activity-based allocation method

Costs
First stage

Activities

Products
Second stage
7

Activity Based Costing :

Activity based costing is an accounting methodology that assigns costs to activities rather than products or services This enables resource and overhead costs to be more accurately assigned to the products and the services that consume them

An Example
Traditional Salaries $100 Equipment $80 Supplies $20 Overhead $45 Total $245 ABC Clean door $40 Paint door $75 Inspect door $75 Send door to assembly $55 Total $245

Basics of A B C
Cost of a product is the sum of the costs of all activities required to manufacture and deliver the product. Products do not consume costs directly Money is spent on activities Activities are consumed by product/services

Basics of A B C (contd.)
ABC assigns Costs to Products by tracing expenses to activities. Each Product is charged based on the extent to which it used an activity
The primary objective of ABC is to assign costs that reflect/mirror the physical dynamics of the business

Basics of A B C (contd.)
Provides ways of assigning the costs of indirect support resources to activities, business processes, customers, products. It recognises that many organisational resources are required not for physical production of units of product but to provide a broad array of support activities.

ABC systems addresses the following Questions:

What activities are being performed by the organisational resources? How much does it cost to perform activities? Why does the oranisation need to perform those activities? How much of each activity is required for the organisations products, services, and customers?

ABC: Where to Use?

High Overheads Product Diversity or Multiple Products Customer Diversity Service Diversity Stiff Competition

Stages and flow of costs in A B C

Steps: 1. Form cost pools 2. Identify activities 3. Map resource costs to activities 4. Define activity cost drivers 5. Calculate cost

Identify Activities
In developing an ABC system, the organisation identifies the activities being performed:
Move material Schedule production Purchase material Inspect items

Activity Dictionary

Respond to customers Improve products Introduce new products Explore new markets

Map resource costs to activities

Financial accounting categorises expenses by spending code; salaries, fringe benefits, utilities, travel, communication, computing, depreciation etc.

ABC collects expenses from this financial system and drive them to the activities performed.

Mapping
Accounting Records Salaries 313,000 Depreciation Electricity Supplies Travel Total 155,000 132,000 25,000 100,000 725,000
Activities Business Development ABC Records Salaries Depreciation lectricity Supplies Travel E 20,000 25000 60000 50000 10000 10000 5000 50000 20000 2000 50000 5000 25000 5000 20000 5000 Total 55,000

Maintianing Present Business 80,000 Purhcasing Material Set up Machines Running Machines Resolve Quality Problems Total 125,000 25,000 50,000 13,000

10000 205,000 60000 275,000 37,000 110,000 43,000

313,000 155000 132000

25000 100000 725,000

Activities: Types
Unit level: Performed each time a unit is
produced

Batch level: Performed each time a batch is

produced

Product level: Performed to support production

of different type of product Customer Level: Performed to support servicing customers

Facility level:Residuary head

Define cost drivers

A cost driver is an activity that generates cost Cost drivers signify factors, forces or events that determine the cost of activities An activity driver is a quantitative measure of the output of an activity The selection of an activity driver reflects a subjective trade-off between accuracy and cost of measurement

Examples of Cost Drivers

Number of purchase orders processed. 2. Number of material requisitions. 3. Number of receipts. 4. Number of setups. 5. Number of machine hours. 6. Number of assembly labor hours. 7. Number of inspections. 8. Number of boxes shipped
1.

Traditional, Volume-Based Product-Costing System

Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records:

Mode I Production: Units Runs 10,000 1 run of 10,000 units Mode II 20,000 4 runs of 5,000 units Mode III 4,000 10 runs of 400 units

Traditional, Volume-Based Product-Costing System

Direct materials Direct labor Manufacturing overhead Total $ $ Mode I 50.00 60.00 99.00 209.00 Mode II $ 90.00 80.00 132.00 $ 302.00 Mode III $ 20.00 40.00 66.00 $ 126.00

Additional information includes:

Direct materials Direct labor (hr/board) Setup time (hr/run) Machine time (hr/board) $ Mode I 50.00 3 10 1 Mode II $ 90.00 4 10 1.25 Mode III $ 20.00 2 10 2

Manufacturing overhead is determined as follows

Traditional, Volume-Based Product-Costing System

Units produced Direct labor (hr/unit) Total hours Total hours required Mode I 10,000 3 30,000 Mode II 20,000 4 80,000 118,000 Mode III 4,000 2 8,000

Budgeted manufacturing overhead Budgeted direct-labor hours

Mode I Direct labor (hr/unit) Overhead rate per hour Overhead per unit $ $

$3,894,000 118,000
Mode II 3 33 99 $ $

= $33 per hour

Mode III 4 33 132 $ $ 2 33 66

Traditional, Volume-Based Product-Costing System

With these product costs, Aerotech established target selling prices (Cost 125%).
Direct materials Direct labor Manufacturing overhead Total $ Mode I Mode II Mode III 50.00 $ 90.00 $ 20.00 60.00 80.00 40.00 99.00 132.00 66.00 209.00 $ 302.00 $ 126.00

Cost per unit Target selling price

Mode I 209.00 261.25

Mode II $ 302.00 377.50

Mode III $ 126.00 157.50

209.00 x 1.25

Overhead Costs Activity Total budgeted cost = $3,894,000 Identification must be of Activity done on Cost Pools Activity each unit Cost produced. Pools

Unit Level
Machinery cost pool $1,212,600

Batch Level
Setup cost pool $3,000

ProductSustaining Level
Engineering cost pool $700,000

Facility Level
Facility cost pool $507,400

Activity performed on each batch produced. 5-27

Activities needed to support an entire product line

Activity required in order for the production process to occur.

Unit Level Machinery cost pool $1,212,600

Batch Level Setup cost pool $3,000 Receiving/Inspection cost pool $200,000 Material-Handling cost pool $600,000 Quality-Assurance cost pool $421,000 Packaging/Shipping cost pool $250,000

ProductSustaining Level Engineering cost pool $700,000

Facility Level Facility cost pool $507,400

STAGE ONE
Various overhead costs related to machinery Maintenance Depreciation Computer Support Lubrication Electricity Calibration

Activity cost pool

Machinery Cost Pool

Total budgeted cost = $1,212,600

STAGE TWO
Calculate the pool rate
Budgeted Machinery Costs = $1,212,600 Budgeted Machine Hours 43,000 = $28.20/hour

Cost Assignment

Mode I: $28.20 per hr. 1 hr. per unit $28.20 per unit

Mode II: $28.20 per hr. 1.25 hr. per unit $35.25 per unit

Mode III: $28.20 per hr. 2 hr. per unit $56.40 per unit

STAGE ONE
Calculation of total setup cost
Total budgeted setup cost $20 per hour 10 hr. per setup $200 cost per setup 15 production runs $ 3,000 Total

Activity cost pool

Setup Cost Pool

Total budgeted cost = $3,000

STAGE TWO
Calculate the pool rate
Budgeted Setup Costs Planned Production Runs = $3,000 15 runs = $200 per run

Cost Assignment

Mode I: (1 Run) $200 per run 10,000 units per run = $.02 per unit

Mode II: (4 Runs) $200 per run 5,000 units per run = $.04 per unit

Mode III: (10 Runs) $200 per run 400 units per run = $.50 per unit

STAGE ONE
Various overhead costs related to engineering Engineering salaries Engineering supplies Depreciation

Engineering software

Activity cost pool

Engineering Cost Pool

Total budgeted cost = $700,000

STAGE TWO
Allocate based on engineering transactions

Engineering Cost Pool

Total budgeted cost = $700,000

Cost Assignment

Mode I: 25% $700,000 10,000 units = $17.50 per unit

Mode II: 45% $700,000 20,000 units = $15.75 per unit

Mode III: 30% $700,000 4,000 units = $52.50 per unit

STAGE ONE
Various overhead costs related to general operations

Plant depr.
Plant mgmt.

Property taxes
Insurance

Plant maint.

Security

Activity cost pool

Facility Cost Pool

Total budgeted cost = $507,400

STAGE TWO
Calculate the pool rate
Budgeted Facilities Cost = $507,400 Budgeted Direct-Labor Hours 118,000 = $4.30/hour

Cost Assignment

Mode I: $4.30 per hr. 3 hr. per unit $12.90 per unit

Mode II: $4.30 per hr. 4 hr. per unit $17.20 per unit

Mode III: $4.30 per hr. 2 hr. per unit $8.60 per unit

Other Overhead Costs

Re c e ivin g an d In s pe c t ion Cos t P ool
Board Mode I Mode II Mode III Ove rh e ad $ 200,000 200,000 200,000 % 6% 24% 70% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 1.20 = 2.40 = 35.00

Mat e rial-Han dlin g Cos t P ool

Board Mode I Mode II Mode III Ove rh e ad $ 600,000 600,000 600,000 % 7% 30% 63% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 4.20 = 9.00 = 94.50

Qu alit y-As s u ran c e Cos t P ool

Board Mode I Mode II Mode III Ove rh e ad $ 421,000 421,000 421,000 % 20% 40% 40% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 8.42 = 8.42 = 42.10

P ac kagin g an d Sh ippin g Cos t P ool

Board Mode I Mode II Mode III Ove rh e ad $ 250,000 250,000 250,000 % 4% 30% 66% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 1.00 = 3.75 = 41.25

Other Overhead Costs

Re c e ivin g an d In s pe c t ion Cos t P ool
Board Mode I Mode II Mode III Ove rh e ad $ 200,000 200,000 200,000 % 6% 24% 70% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 1.20 = 2.40 = 35.00

Mat e rial-Han dlin g Cos t P ool

$14.82

Board Mode I Mode II Mode III

Ove rh e ad $ 600,000 600,000 600,000

% 7% 30% 63%

Un its 10,000 20,000 4,000

= Cos t/Un it = $ 4.20 = 9.00 = 94.50

Qu alit y-As s u ran c e Cos t P ool

Board Mode I Mode II Mode III Ove rh e ad $ 421,000 421,000 421,000 % 20% 40% 40% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 8.42 = 8.42 = 42.10

P ac kagin g an d Sh ippin g Cos t P ool

Board Mode I Mode II Mode III Ove rh e ad $ 250,000 250,000 250,000 % 4% 30% 66% Un its 10,000 20,000 4,000 = Cos t/Un it = $ 1.00 = 3.75 = 41.25

Product Cost from ABC

These are the new product costs when Aerotech uses ABC.
Mode I Direct materials $ 50.00 Direct labor 60.00 Machinery 28.20 Setup 0.02 Engineering 17.50 Facilities 12.90 Other 14.82 Total $ 183.44 Mode II $ 90.00 80.00 35.25 0.04 15.75 17.20 23.57 $ 261.81 Mode III $ 20.00 40.00 56.40 0.50 52.50 8.60 212.85 $ 390.85

Distorted Product Costs

Both original and ABC target selling prices are based on (Cost 125%).
Tradition al cos tin g ABC cos tin g Origin al targe t s e llin g price ABC targe t s e llin g price Mode I $ 209.00 183.44 261.25 229.30 Mode II $ 302.00 261.81 377.50 327.26 Mode III $ 126.00 390.85 157.50 488.56

The selling price of Mode I and II are reduced and the selling price for Mode III is increased.
[$209.00 1.25] [$183.44 1.25]

Benefits of Activity-Based Costing

Increased accuracy and reliability in product costing by focusing on activities Identification of non value added activities Better accountability and traceability of costs Enables easy decision making with respect to product pricing

Limitations of Activity-Based Costing

Can be expensive to use.

Manufacturing environment defines application of this method.

Relatively more complex than traditional systems.

Difficulties in practical implementation.

References

Magagerial Accounting
by Ronald .W.Hilton. Tata McGraw Hill

Managerial Accounting
Second Edition by Weygandt / Kieso / Kimmel

Cost Accounting
by Horngren , Datar , Foster, Prentice Hall Business Publishing

Thank You..