5 Activity Based Costing
Question 1 Discuss the different stages in the Activity –based Costing. (Nov., 2003, 4 marks)
Answer Different stages in activity –based costing
(i)
Iden dentify ify the dif different activit ivitiies with ithin the organ ganiza ization ion
(ii)
Relat late th the o ov verhea heads cost to to th the ide ident ntif ifie ied d ac activ tivitie ities s
(iii) Support activities are then spread across the primary activities (iv) (iv) (v) (vi) (vi)
Dete Determ rmin ine e the the acti activi vity ty cost cost driv driver ers s
Calculate the activity cost dr driver rates Comput Comp ute e the the over verhea head co cost to to be char charge ged d over ver the the prod produc uctt by using cost driver rates.
Question 2 Give Give thre three e exam exampl ples es of Cost Cost Driv Driver ers s of foll follow owin ing g busi busine ness ss functions in the value chain: (i )
Re se ar ch a nd de ve l opme n t
(ii )
Design of of p prroducts, se services an and pr processes
(ii i )
M ar k e ti ng
(i v)
D i s t r i bu t i o n
(v)
Customer service (May, 2000, 5 marks)
Answer
A cost driver is any factor whose change causes a change in the total cost of a related cost object. In other words, a change in the
5.2
Cost Accounting
level of cost driver will cause a change in the level of the total cost of a related cost object. The cost cost driv driver ers s for for bus busines iness s func functi tion ons s viz. viz. Resea esearc rch h & Dev Develo elopmen pment; t; Desi Design gn of pro product ducts s, serv servic ices es and pro process cesses es;; Marketing; Distribution and Customer service are as follows: Bu si ne ss fun cti on s
C o st D r i v e r s
(i) Research & Development projects
-
Number of research
Personnel hours on a project Technical Technical complexities complexities of the projects (ii) Design of products, services and processes Numb er of products in design Number of parts per product Numbe umberr of engi engine neer erin ing g hours ( i i i ) Ma r k e t i n g Nu m b e r of advertisement run Number of sales personnel Sales revenue Numb Number er of produc products ts and and v ol u m e of s al e s (in quantitative terms) ( i v ) D i st r i b u t i o n Nu m b e r of i tems distributed Number of customers W ei g h t of i tems distributed (v) Customer service Number of service calls Nu m b e r of products serviced Hours spent in servicing of products -
Question 3
5.2
Cost Accounting
level of cost driver will cause a change in the level of the total cost of a related cost object. The cost cost driv driver ers s for for bus busines iness s func functi tion ons s viz. viz. Resea esearc rch h & Dev Develo elopmen pment; t; Desi Design gn of pro product ducts s, serv servic ices es and pro process cesses es;; Marketing; Distribution and Customer service are as follows: Bu si ne ss fun cti on s
C o st D r i v e r s
(i) Research & Development projects
-
Number of research
Personnel hours on a project Technical Technical complexities complexities of the projects (ii) Design of products, services and processes Numb er of products in design Number of parts per product Numbe umberr of engi engine neer erin ing g hours ( i i i ) Ma r k e t i n g Nu m b e r of advertisement run Number of sales personnel Sales revenue Numb Number er of produc products ts and and v ol u m e of s al e s (in quantitative terms) ( i v ) D i st r i b u t i o n Nu m b e r of i tems distributed Number of customers W ei g h t of i tems distributed (v) Customer service Number of service calls Nu m b e r of products serviced Hours spent in servicing of products -
Question 3
Activity Based Costing
5.3
MNP MNP su suits its is a ready ready-to -to-we -wear ar su suit it manu manufac factu turer rer.. It has four four customers: customers: two wholesale-channel wholesale-channel customers and two retail-channel customers. MNP sui suits ts has developed developed the followin following g activity activity-base -based d costing costing system: Acti vi ty O r d e r p r o c e ss i n g S a l e s vi s i t s Delive Delivery ry–re –regul gular ar D e l i v e r y- r u s h e d
Cost driver Rate in 20 0 4 Number of purchase Rs. 1,225 per order orders Number of customer Rs. 7,150 per visit visits Numb Number er of regula regular r Rs. 1 ,5 00 per deliveries delivery Number of rushed Rs. 4 ,2 50 per deliveries delivery
List selling price per suit is Rs. 1000 and average cost per suit is Rs. 550. The CEO of MNP suits wants to evaluate the profitability of each each of the the four four custo customer mers s in 2003 2003 to explo explore re oppor opportun tuniti ities es for for increasing profitability of his company in 2004. The following data are available for 2003: Ite m
Whol e sal e customers
T o t a l nu m b e r o f o r d e r s T o t a l n u m b e r o f s a l e s v i si t s Re g ul a r d el i ve ri e s Rush deliveries Average number of suits per order Average selling price per suit
Retail customers
W
H
R
T
44
62
2 12
25 0
8
12
22
20
41
48
1 66
19 0
3
14
46
60
400
200
30
25
Rs. 7 0 0
R s. 800
Rs. 850
Rs. 900
Required : (i )
Calculate th the cu customer-le -level op operating in income in in 20 2003.
(ii )
Wh at d do o yo you re recommend to t o CE C EO of of MN M NP su suits to to do d o to to increase the company’s operating income in 2004?
(ii i )
Assume MNP suits’ distribution channe l costs are Rs. 17,50,000 for its wholesale customers and Rs. 10,50,000 for the retail retail cust custom omers ers.. Als Also, o, assu assume me that that its its corpo corporat rate e su sust stain aining ing
Cost Accounting
5.4
costs are Rs. 12,50,000. Prepare Income statement of MNP suits for 2003. (Nov., 2004, 6+2+2=10 marks)
Answer (i)
Customer Profitability Analysis, Customer cost hierarchy
Item
W
H
R
T
Revenue
Rs
Rs
Rs
Rs
1,76,00, 000
1,24,00, 000
63,60,0 00
62,50,0 00
52,80,00 0 1,23,20, 000
24,80,00 0 99,20,00 0
9,54,00 0 54,06,0 00
6,25,00 0 56,25,0 00
96,80,00 0
68,20,00 0
34,98,0 00
34,37,5 00
26,40,00 0
31,00,00 0
19,08,0 00
21,87,5 00
At list price (Rs) 44x400=17600 62x200=12400 212x30=6360 250x25=6250 17600x1000,12400x1000,6360x 10006250x 1000
Discount
1000-700=300 1000-800=200 1000-850=150 1000-900=100 17600x300,12400x200, 6360x150,6250x100
Revenues at actual prices
Cost of Goods Sold 17600x550 12400x550 6360x550 6250x550
Gross Margin
Activity Based Costing
5.5
Customer level operating Costs:
Order processing (44,62,212,250) x (Rs1,225) Sales visits (8,12,22,20)X(Rs 7,150) Delivery regular (41,48,166,190) x (Rs 1,500) Delivery rushed (3,14,46,60) (Rs 4,250)
53,900
75,950
57,200
85,800
61,50 0 12,750
72,000 59,500
Total customer level operating cost
1,85,350
2,93,250
Customer level operating income
24,54,65 0 19.92
Customer level operating income as %age on revenues at actual prices
(ii)
2,59,70 0 1,57,30 0 2,49,00 0 1,95,50 0
3,06,25 0 1,43,00 0 2,85,00 0 2,55,00 0
28,06,75 0
8,61,50 0 10,46,5 00
9,89,25 0 11,98,2 50
28.29
19.35
21.30
Key Challenges facing CEO are –
(i)
Reduce level of price discounting, especially by W
(ii)
Reduce level of customer-level costs, especially by R & T
The ABC cost system highlights areas where R & T accounts are troublesome They have •
High number of orders
•
High number of customer visits
•
High number of rushed deliveries
The CEO needs to consider whether this high level of activity can be reduced without reducing customer revenues. (ii) (in Rs)
Income Statement of MNP suits for 2003
Customer income Less:
level
Distribution
operating
channel
Wholesal e Customer s Rs 52,61,40 0 17,50,00
Retail Customers
Rs 22,44,750 10,50,000
Total
Rs 75,06,15 0 28,00,00
5.6
Cost Accounting
cost Distribution channel level operating income Less: Corporate sustaining costs Operating Income
0 35,11,40 0
11,94,750
0 47,06,15 0 12,50,00 0 34,56,15 0
Activity Based Costing
5.7
Question 4 MST Limited has collected the following data for its two activities. It calculates activity cost rates based on cost driver capacity. Activity Power
Cost Driver Kilowatt hours
Quality Inspections
Number of Inspections
Capacity 50,000 kilowatt hours 10,000 Inspections
Cost Rs. 2,00,000 Rs. 3,00,000
The company makes three products M,S and T. For the year ended March 31, 2004, the following consumption of cost drivers was reported: Product M S T
Kilowatt hours 10,000 20,000 15,000
Quality Inspections 3,500 2,500 3,000
Required: (i) Compute the costs allocated to each product from each activity. (ii) Calculate the cost of unused capacity for each activity. (iii) Discuss the factors the management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate. (May, 2004, 6 marks)
Answer (i)
Statement of cost allocation to each product from each activity Product
Power (Refer to working note) Quality Inspections (Refer to working
M
S
T
Total
Rs.
Rs.
Rs.
40,000 (10,000 kwh x Rs.4)
80,000 (20,000 kwh x Rs.4)
60,000 (15,000 kwh x Rs.4)
1,80,0 00
1,05,000
75,000
90,000
(3,500 inspections x Rs. 30)
(2,500 inspections x Rs. 30)
(3,000 inspections x Rs. 30)
2,70,0 00
Rs.
Cost Accounting
5.8
note)
Working note : Rate per unit of cost driver:
P ow e r
:
(Rs. 2,00,000 / 50,000 kwh) = Rs. 4/kwh
Qual Qualit ity y Insp Inspec ecti tio on : 30 per inspection (i i)
Computation activity:
(Rs. (Rs. 3,00 3,00,0 ,000 00 / 10,0 10,000 00 ins inspect pectio ions ns)) = Rs.
of
cost
of
u nu s e d
Power (Rs. 2,00,000 – Rs. 1,80,000) Quality Inspections (Rs. 3,00,000 – Rs. 2,70,000) Total cost of unused capacity (iii (iii))
ca p a c i t y
for
e ac h
Rs. 20,000
30,000 50,000
Fact Factor ors s mana manage geme ment nt cons consid ider er in choo choosi sing ng a capa capaci city ty leve levell to comp compute ute the the budg budgete eted d fixed fixed overh overhea ead d cost cost rate:
-
Effe Effect ct on prod product uct cost costing ing & cap capac acity ity mana manage geme ment nt
-
Eff Effect on on pr pricin icing g de decisio ision ns.
-
Effe Effect ct on on perf perfo orman rmance ce eva evalu lua atio tion
-
Effe Effect ct on fina financ ncia iall sta state tem ments ents
-
Regula gulattory re requir uirements nts.
-
Diffic Difficult ulties ies in fore foreca cast sting ing cho chose sen n capac capacity ity lev level el conc concept epts. s.
Q u e st i o n 5 RST Limited Limited specializ specializes es in the distribu distribution tion of pharmac pharmaceutic eutical al products. It buys from the pharmaceutical companies and resells to each of the three different markets. (i )
Ge n e ra l Sup e rmar k e t Ch ai ns
(ii )
D r ug stor e C hai n s
(ii i )
Chemist Shops
The following data for the month of April, 2004 in respect of RST Limited has been reported: General Supermarket
Drugstore Chains
Chemist Shops
Activity Based Costing
Chains Average revenue per Rs. 84,975 delivery Ave r ag e cost of Rs. 82,500 go od s sol d per delivery Numbe r of d el i ve r ie s Rs. 33 0
Rs. 28,875 Rs. 27,500
Rs. 5,445
Rs. 8 25
Rs. 2,750
5.9
Rs.4,950
In the past, RST Limited has used gross margin percentage to evaluate the relative profitability of its distribution channels. The company plans to use activity –based costing for analysing the profitability of its distribution channels.
5.10
Cost Accounting
The Activity analysis of RST Limited is as under: Acti vi ty Ar e a C o st D r i v e r C ustome r pu rch ase order Purchase orders by customers processing Li ne -i t e m or d e ri ng Line-items per purchase order St ore de li ve r y Sto re de li ve ri e s Cart Carto ons dis dispat patched hed to stores Cart artons ons dis dispa pattched hed to a store per delivery ShelfShelf-st stoc ockin king g at at cus custom tomer er sto store re Hours Hours of shelfshelf-st stoc ockin king g The April, 2004 operating costs (other than cost of goods sold) of RST Limited are Rs. 8,27,970. These operating costs are assigned to five activity areas. The cost in each area and the quantity of the cost allocation basis used in that area for April, 2004 are as follows: Acti vi ty Ar e a
Tota l costs April, 2004
Customer Customer purchase purchase order order Rs. 2,20,000 processing Li ne -i t e m or d e ri ng Rs. 1 ,7 5,5 60 St ore de li ve r y Rs. 1 ,9 5,2 50 C ar ton s dispatched to Rs. 2 ,0 9,0 00 store Shelf-stocking at customer Rs. 28,160 store
in
Tota Totall Unit Units s of Cos Cost Alloca Al location tion Base Base used in April, 2004 5,5 00 or d e rs 58,520 line items 3,9 05 stor e deliveries 2,0 9,0 0 0 ca rto n s 1,7 60 h ou rs
Other data for April, 2004 include the following: General Supermar ket Chains T o t a l nu m b e r o f o r d e r s 385 Average number of line items per 14 order Total number of store deliveries 330 Ave r ag e numb e r of car to ns 3 0 0 shipped per store delivery Average number of hours of shelf- 3 stocking per store delivery
Drugsto re Chains
Chemist Shops
9 90 12
4 ,1 25 10
8 25 80
2 ,7 50 16
0 .6
0 .1
Activity Based Costing
5.11
Required: (i) Compute for April, 2004 gross-margin percentage for each of its three distribution channels and compute RST Limited’s operating income. (ii) Compute the April, 2004 rate per unit of the cost-allocation base for each of the five activity areas. (iii) Compute the operating income of each distribution channel in April, 2004 using the activity-based costing information. Comment on the results. What new insights are available with the activity-based cost information? (iv) Describe four challenges one would face in assigning the total April,2004 operating costs of Rs. 8,27,970 to five activity areas. (May, 2004, 12 marks)
Answer (i)
RST Limited’s Statement of operating income and gross margin percentage for each of its three distribution channel General Super Market Chains
Drugstore Chains
Chemist Shops
2,80,41,750 (330 x Rs. 84,975)
2,38,21,875 (825 x Rs. 28,875)
1,49,73,75 0
6,68,37,3 75
Less: Cost of goods sold: (Rs.)
2,72,25,000
2,26,87,500
(330 x Rs 82,500)
(825 x 27,500)
(2,750 x Rs. 5,445) 1,36,12,50 0
635,25,0 00
Gross Margin: (Rs.)
8,16,750
11,34,375
Revenues: (Rs.)
Rs
Total
(2,750 x Rs 4,950) 13,61,250
33,12,37 5
Less: Other
operating costs:
8,27,970
(Rs)
Operating income: (Rs.) Gross Margin
24,84,40 5 2.91%
4.76 %
9.09%
4.96%
5.12
Cost Accounting
Operating income %
(ii)
3.72
Computation of rate per unit of the cost allocation base for each of the five activity areas for April 2004
Customer purchase order processing (Rs. 2,20,000/ 5,500 orders) Line item ordering (Rs. 1,75,560/ 58,520 line items) Store delivery (Rs. 1,95,250/ 3,905 store deliveries) Cartons dispatched (Rs. 2,09,000/ 2,09,000 dispatches) Shelf-stocking at customer store (Rs.) (Rs. 28,160/ 1,760 hours)
Rs. 40/ order
3/ line item order
50/ delivery
1/ dispatch
16/ hour
Activity Based Costing
5.13
(iii) Operating Income Statement of each distribution channel in April-2004 (Using the Activity based Costing information)
Gross margin (Rs.) : (A) (Refer to (i) part of the answer) Operating cost (Rs.) : (B) (Refer to working note) Operating income (Rs.) : (A–B) Operating income (in %) (Operating income/ Revenue) x 100
General Super market Chains 8,16,750
Drugstore Chains
Chemist Shops
11,34,375
13,61,260
1,62,910
1,90,410
4,74,650
6,53,840
9,43,965
8,86,600
2.33
3.96
5.96
Comments and new insights: The activity-based cost information highlights, how the ‘Chemist Shops’ uses a larger amount of RST Ltd’s resources per revenue than do the other two distribution channels. Ratio of operating costs to revenues, across these markets is:
General supermarket chains (Rs. 1,62,910/ Rs. 2,80,00,750) x 100 Drug store chains (Rs. 1,90,410/ Rs. 2,38,21,875) x 100 Chemist shops (Rs. 4,74,650/ Rs. 1,49,73,750) x 100
0.58%
0.80%
3.17%
Working note: Computation of operating cost of each distribution channel: General Super Drugstore market Chains Chains Rs. Rs. Customer 15,400 39,600 purchase order (Rs. 40 x 385 (Rs. 40 x 990 processing orders) orders)
Chemist Shops Rs.
1,65,000 (Rs. 40 x 4125 orders)
5.14
Cost Accounting
Line ordering
item 16,170 (Rs. 3 x 14 x 385) Store delivery 16,500 (Rs. 50 x 330 deliveries)
35,640 (Rs. 3 x 12 x 990) 41,250 (Rs. 50 x 825 deliveries)
Cartons dispatched
66,000 (Re. 1 x 80 cartons x 825 deliveries)
Shelf stocking
Operating cost
99,000 (Re. 1 x 300 cartons x 300 deliveries)
15,840 7,920 (Rs. 16 x 330 (Rs. 16 x 825 deliveries x 3 deliveries x 0.6 Av. hrs.) Av. hrs) 1,62,910
1,90,410
1,23,750 (Rs. 3 x 10 x 4125) 1,37,500 (Rs. 50 x 2750 deliveries) 44,000 (Re. 1 x 16 cartons x 2,750 deliveries) 4,400 (Rs. 16 x 2,750 deliveries x 0.1 Av. hrs) 4,74,650
(iv) Challenges faced in assigning total operating cost of Rs. 8,27,970 :
-
Choosing an appropriate cost driver for activity area.
-
Developing a reliable data base for the chosen cost driver.
Deciding, how to handle costs that may be common across several activities. -
Choice of the time period to compute cost rates per cost driver.
-
Behavioural factors.
Question 6 Alpha Limited has decided to analyse the profitability of its five new customers. It buys bottled water at Rs. 90 per case and sells to retail customers at a list price of Rs. 108 per case. The data pertaining to five customers are:
Cases sold List Selling Price Actual Selling Price
A 4,680 Rs. 108 Rs.
Customers B C D 19,688 1,36,8 71,550 00 Rs. 108 Rs. Rs. 108 108 Rs. Rs. 99 Rs.
E 8,775 Rs. 108 Rs.
Activity Based Costing
Number of Purchase orders Number of Customer visits Number of deliveries Kilometers travelled per delivery Number of expedited deliveries
108 15
106.20 25
2
5.15
97.20
30
104.40 25
3
6
2
3
10 20
30 6
60 5
40 10
20 30
0
0
0
0
1
30
Its five activities and their cost drivers are: Activity Order taking Customer visits Deliveries Product handling Expedited deliveries
Cost Rs. Rs. Rs. Rs. Rs.
Driver Rate 750 per purchase order 600 per customer visit 5.75 per delivery Km traveled 3.75 per case sold 2,250 per expedited delivery
Required: (i) Compute the customer-level operating income of each of five retail customers now being examined (A, B, C, D and E). Comment on the results. (ii) What insights are gained by reporting both the list selling price and the actual selling price for each customer? (iii) What factors Alpha Limited should consider in deciding whether to drop one or more of five customers? (Nov., 2003, 7+3+2= 12 marks)
Answer Working note: Computation of revenues (at listed price), discount, cost of goods sold and customer level operating activities costs: Customers A
Cases (a)
sold: 4,680
B
C
D
E
19,688
1,36,800
71,550
8,775
5.16
Cost Accounting
Revenues (at 5,05,44 21,26,3 listed price) 0 04 (Rs.): (b) {(a) x 108)}
77,27,40 0
9,47,700
12,31,20 0
2,57,580
94,770
Rs.
Discount (Rs.): (c) {(a) Discount case}
1,47,74,4 00
x per
35,438
(19,688 (71,550 (8,775 cases x (1,36,800 cases x cases Rs. cases x Rs. 3.60) Rs. 1.80) Rs. 9) 10.80)
Cost of goods 4,21,20 17,71,9 sold (Rs.) : (d) 0 20
1,23,12,0 00
64,39,50 0
7,89,750
{(a) x Rs. 90}
Customer level operating activities costs
Order taking 11,250 costs (Rs.): (No. purchase orders x 750)
18,750
22,500
18,750
22,500
1,800
3,600
1,200
1,800
1,035
1,725
2,300
3,450
of Rs.
Customer 1,200 visits costs (Rs.) (No. of customer visits x Rs. 600)
Delivery 1,150 vehicles travel costs (Rs.) (Rs. 5.75 per km) (Kms traveled by delivery vehicles x Rs. 5.75 per km.)
x
Activity Based Costing
Product 17,550 handling costs (Rs.) {(a) x Rs. 3.75} Cost of expediting deliveries (Rs.) {No. of expedited deliveries x Rs. 2,250} Total cost of 31,150 customer level operating activities (Rs.) (i) income
5.17
73,830
5,13,000
2,68,313
32,906
-
-
-
2,250
95,415
5,40,825
2,90,563
62,906
Computation of Customer level operating
A Rs. 5,05,44 0
Customers B C Rs. Rs. 21,26,3 1,47,74, 04 400
Revenues (At list price) (Refer to working note) Less: Discount 35,438 12,31,2 00 (Refer to working _______ _______ note) 5,05,4 20,90,8 1,35,43 Revenue 40 66 ,200 (At actual price) Less: Cost of 4,21,20 17,71,9 1,23,12, goods sold 0 20 000 (Refer to working note) _______ _______ _______ Gross margin 84,240 3,18,94 12,31,2 6 00 Less: Customer 31,150 95,415 5,40,82 level operating 5
D Rs. 77,27,4 00
E Rs. 9,47,70 0
2,57,58 94,770 0 _______ _______ 74,69, 8,52,9 820 30 64,39,5 00
7,89,75 0
_______ _______ 10,30,3 63,180 20 2,90,56 62,906 3
5.18
Cost Accounting
activities costs (Refer to working note) Customer level operating income
_______ 53,090
_______ 2,23,53 1
_______ _______ 6,90,37 5
_______ 7,39,75 7
274
Comment on the results:
Customer D is the most profitable customer, despite having only 52.30% of the unit volume of customer C. The main reason is that C receives a Rs. 9 per case discount while customer D receives only a Rs. 3.60 discount per case. Customer E is less profitable, in comparison with the small customer A being profitable. Customer E received a discount of Rs. 10.80 per case, makes more frequent orders, requires more customer visits and requires more delivery kms. in comparison with customer A. (ii) Insight gained by reporting both the list selling price and the actual selling price for each customer:
Separate reporting of both-the listed and actual selling prices enables Alpha Ltd. to examine which customer has received what discount per case, whether the discount received has any relationship with the sales volume. The data given below provides us with the following information; Sales volume C (1,36,800 cases) D (71,550 cases) B (19,688 cases) E (8,775 cases) A (4,680 cases)
Discount per case (Rs.) 9.00 3.60 1.80 10.80 0
The above data clearly shows that the discount given to customers per case has a direct relationship with sales volume, except in the case of customer E. The reasons for Rs. 10.80 discount per case for customer E should be explored. (iii) Factors to be considered for dropping one or more customers:
Dropping customers should be the last resort to be taken by Alpha Ltd. Factors to be considered should include: What is the expected future profitability of each customer? Are the currently least profitable (E) or low profitable (A) customers are likely to be highly profitable in the future?
Activity Based Costing
5.19
What costs are avoidable if one or more customers are dropped? Can the relationship with the “problem” customers be restructured so that there is at “win win” situation? Question 7 Family Store wants information about the profitability of individual product lines: Soft drinks, Fresh produce and Packaged food. Family store provides the following data for the year 2002-03 for each product line:
5.20
Cost Accounting
Soft drinks
Fresh produce
Revenues
Rs. 7,93,500
Rs. 21,00,600
Rs. 12,09,900
Cost of goods sold
Rs. 6,00,000
Rs. 15,00,000
Rs. 9,00,000
Cost of bottles returned Number of purchase orders placed Number received Hours time
Rs. 0
Rs. 0
360
840
360
deliveries
300
2,190
660
shelf-stocking
540
5,400
2,700
1,26,000
11,04,000
3,06,000
of
of
Rs. 12,000
Packaged food
Items sold
Family store also provides the following information for the year 2002-03: Activity Bottles returns
Ordering
Delivery
Shelf stocking
Customer Support
Description of Total cost Activity Returning of Rs. 12,000 empty bottles Placing of Rs. orders for purchases Physical Rs. delivery and receipt of goods Stocking of Rs. goods on store shelves and ongoing restocking Assistance Rs. provided to customers including
1,56,000
Cost-allocation Base Direct tracing to soft drink line 1,560 purchase orders
2,52,000
3,150 deliveries
1,72,800
8,640 hours of shelf-stocking time
3,07,200
15,36,000 items sold
Activity Based Costing
5.21
check-out Required: (i)
Family store currently allocates support cost (all cost other than cost of goods sold) to product lines on the basis of cost of goods sold of each product line. Calculate the operating income and operating income as a % of revenues for each product line.
(ii)
If Family Store allocates support costs (all costs other than cost of goods sold) to product lines using and activity based costing system, calculate the operating income and operating income as a% of revenues for each product line.
(iii)
Comment on your answers in requirements (i) and (ii). (May, 2003, 3+7+2=12 marks)
5.22
Cost Accounting
Answer (i)
Statement of Operating income and Operating income as a percentage of revenues for each product line
(When support costs are allocated to product lines on the basis of cost of goods sold of each product) Soft Drinks Rs.
Fresh Produce Rs.
7,93,50 0 Cost of Goods sold 6,00,00 (COGS): (B) 0 Support cost (30% of 1,80,00 COGS): (C) 0 Total cost: (D) = {(B) + 7,80,00 (C)} 0 Operating income: E= 13,500 {(A)-(D)} Operating income as a 1.70% percentage of revenues: (E/A) x 100)
21,00,60 0 15,00,00 0 4,50,000
Revenues: (A)
19,50,00 0 1,50,600 7.17%
Packag Total Rs. ed Foods Rs. 12,09,9 41,04,000 00 9,00,00 30,00,000 0 2,70,00 9,00,000 0 11,70,0 39,00,000 00 39,900 2,04,000
3.30%
4.97%
Working notes:
1. Total support cost: Rs. 12,000 1,56,000 2,52,000 1,72,800 3,07,200 9,00,000
Bottles returns Ordering Delivery Shelf stocking Customer support Total support cost
2. Percentage of support cost to cost of goods sold (COGS):
=
Total support cost Total cost of goods sold
100
×
Activity Based Costing
=
Rs.9,00,000
Rs.30,00,000
100
×
= 30%
5.23
5.24
Cost Accounting
3. Cost for each activity cost driver: Activity (1)
Total cost Rs. (2)
Ordering
1,56,000
Delivery
2,52,000
Shelf-stocking
1,72,800
Customer support
3,07,200
Cost allocation base (3) 1,560 purchase orders 3,150 deliveries 8,640 hours
15,36,000 items sold
Cost driver rate (4)=[(2) ÷(3)]
100 per purchase order 80 per delivery 20 per stocking hour 0.20 per item sold
(ii) Statement of Operating income and Operating income as a percentage of revenues for each product line (When support costs are allocated to product lines using an activitybased costing system) Soft drinks
Fresh Produce Rs.
Packaged Food Rs.
12,09,900
12,000 36,000
21,00,60 0 15,00,00 0 0 84,000
0 36,000
41,04,00 0 30,00,00 0 12,000 1,56,000
24,000
1,75,200
52,800
2,52,000
10,800
1,08,000
54,000
1,72,800
25,200
2,20,800
61,200
3,07,200
20,88,00 0 85,500 12,600
11,04,000
39,00,00 0 2,04,000
Revenues: (A)
Rs. 7,93,500
Cost & Goods sold
6,00,000
Bottle return costs Ordering cost* (360:840:360) Delivery cost* (300:2,190:660) Shelf stocking cost* (540:5,400:2,700) Customer Support cost* (1,26,000:11,04,000: 3,06,000) Total cost: (B) Operating income C: {(A)- (B)}
7,08,000
9,00,000
1,05,900
Total Rs.
Activity Based Costing
Operating income as a % of revenues
10.78%
0.60%
8.75%
5.25
4.97%
* Refer to working note 3
(iii) Comment: Managers believe that activity based costing (ABC) system is more credible than the traditional costing system. The ABC system distinguishes with different type of activities at family store more precisely. It also tracks more precisely how individual product lines use resources.
Cost Accounting
5.26
Soft drinks consume less resources than either fresh produce or packaged food. Soft drinks have fewer deliveries and require less shelf stocking time. Family store managers can use ABC information to guide their decisions, such as how to allocate a planned increase in floor space. Pricing decision can also be made in a more informed way with ABC information. Question 8 A B C D Co. Ltd. produces and sells four products A, B, C and D. These products are similar and usually produced in production runs of 10 units and sold in a batch of 5 units. The production details of these products are as follows: Product
A
B
C
D
100
110
120
150
material
30
40
35
45
Direct labour (Rs.)
25
30
30
40
5
4
3
4
Production (Units) Cost per unit: Direct (Rs.)
Machine hour (per unit)
The production overheads during the period are as follows: Rs. Factory works expenses
22,500
Stores receiving costs
8,100
Machine set up costs
12,200
Cost relating to quality control
4,600
Material handling and dispatch
9,600
Rs. 57,000
The cost drivers for these overheads are detailed below: Cost
Cost drivers
Factory works expenses
Machine hours
Stores receiving costs
Requisitions raised
Machine set up costs
No. of production
Activity Based Costing
5.27
runs Cost relating to quality control
No. of production runs
Material handling and dispatch
No. of orders executed
The number of requisitions raised on the stores was 25 for each product and number of orders executed was 96, each order was in a batch of 05 units.
Cost Accounting
5.28
Required: (i) Total cost of each product assuming the absorption of overhead on machine hour basis; (ii) Total cost of each product assuming the absorption of overhead by using activity base costing; and (iii)
Show the differences between (i) and (ii) and comment. (4+4+4=12 marks)
Answer (i) Statement showing total cost of each product assuming absorption of overheads on Machine Hour Rate Basis.
Particulars
A
B
C
D
Total
100
110
120
150
480
Direct material (Rs.)
30
40
35
45
150
Direct Labour (Rs.)
25
30
30
40
125
Direct labour- Machine hrs
5
4
3
4
Overhead @ Rs 30/- per Machine hr
150
120
90
120
480
Total cost per unit (Rs.)
205
190
155
205
755
20,5 00
20,9 00
18,6 00
30,7 50
90,7 50
Output (units)
Total cost (Rs.)
Overhead Rate =
(ii)
Total Overhead Cost Total MHrs .
Total Overheads
=
Rs. 57,000 =Rs. 30 per unit 1,900
Rs
Factory works expenses
22,5 Factory 00 per unit
Stores receiving cost
8,10 Stores 0 receiving cost
Machine set up costs
12,2 Machine set-up 00 cost
12,200 / 48 = Rs. 254.1
Costs relating to quality control
4,60 Cost relating to 0 QC
4,600/48 =Rs 95.83
Expense relating
to
Material handling
exp
22,500 / 1,900= Rs. 11.84 8100 / 100 = Rs. 81
&
9,600 / 96 = Rs.
Activity Based Costing
material handling dispatch Total
&
9,60 dispatch 0 57,0 00
5.29
100/-
Cost Accounting
5.30
Statement showing total cost of each product assuming activity based costing. Particulars
A
B
C
D
Tota l
100
110
120
150
480
No. of production runs
10
11
12
15
48
No. of stores requisition
25
25
25
25
100
No. of sales orders
20
22
24
30
96
Direct
30.00
40.00
35.00
45.00
Unit costs - Direct labour (Rs.)
25.00
30.00
30.00
40.00
Unit costs - Factory works expenses (Rs.)
59.20
47.36
35.52
47.36
Unit costs Stores receiving cost (Rs.)
20.25
18.41
16.88
13.50
Unit costs - Machine setup cost (Rs.)
25.42
25.42
25.42
25.42
9.58
9.58
9.58
9.58
20.00
20.00
20.00
20.00
Unit cost (Rs.)
189.4 5
190.77
172.40
200.8 6
Total cost (Rs)
18,94 5
20,984. 7
20,688. 00
30,12 9
Output (Units)
Unit costs material (Rs.)
-
Unit costs – QC (Rs.) Unit costs – Handling (Rs.)
Material
(iii)
Statement
showing
differences
(in
Rs) Particulars Unit cost MHR Unit cost ABC Unit cost difference Total cost MHR Total cost ABC
-
A 205 189.45 15.55
20,500 18,945
B 190 190.77 -0.77
20,900 20,985
C 155 172.40 -17.40
18,600 20,688
D 205 200.86 4.14
30,750 30,128
The difference is that A consumes comparatively more of Machine hours.
Activity Based Costing
5.31
The use of activity based costing gives different product costs than what were arrived at by utilising traditional costing. It can be argued that Product costs using ABC are more precise as overheads have been identified with specific activities. Question 9 ABC Limited manufactures two radio models, the Nova which has been produced for five years and sells for Rs. 900, and the Royal, a new model introduced in early 2004, which sells for Rs. 1,140. Based on the following Income statement for the year 2004-05, a decision has been made to concentrate ABC Limited’s marketing resources on the Royal model and to begin to phase out the Nova model.
ABC Limited Income Statement for the year ending March 31, 2005 Royal Nova Total Model Model Rs. Rs. Rs. Sales 45,60,0 1,98,00, 2,43,60, 00 000 000 Cost of Goods sold 31,92,0 1,25,40, 1,57,32, 00 000 000 Gross margin 13,68,0 72,60,00 86,28,00 00 0 0 Selling & Administrative 9,78,00 58,30,00 68,08,00 Expenses 0 0 0 Net Income 3,90,00 14,30,00 18,20,00 0 0 0 Unit Produced and sold 4,000 22,000 Net Income per unit sold 97.50 65 The standard unit costs for the Royal and Nova models are as follows:
Direct materials
Royal Model
Nova Model
Rs.
Rs.
584
208
Direct Labour Royal (3.5 hrs x Rs. 12) Nova (1.5 hrs x Rs. 12)
42 18
5.32
Cost Accounting
Machine usage Royal (4 hrs x Rs. 18)
72
Nova (8 hrs x Rs. 18)
144
Manufacturing overheads (applied on the basis of machine hours at a predetermined rate of Rs. 25 per hour)
100
200
Standard Cost 798 570 ABC Ltd.'s Controller is advocating the use of activity-based costing and activity-based cost management and has gathered the following information about the company's manufacturing overheads cost for the year ending March 31, 2005. Activity driver)
centre
(Cost Traceabl e Costs Rs.
Number of Events
Royal
Nova
Total
3,85,0 00
11,85, 000
15,70, 000
Shipments (Number of shipments) 8,60,000
3,800
16,200
20,000
Quality (Number Shipments)
21,30 0
56,200
77,500
9,50,400
1,09,9 80
80,100
1,90,0 80
57,600
16,00 0
1,76,0 00
1,92,0 00
7,50,000
14,00 0
16,000
30,000
Soldering (Number of solder joints) 9,42,000
control of 12,40,00 0
Purchase orders (Number of orders) Machine Power (Machine hours) Machine setups (Number of setups) Total Traceable costs
Required:
48,00,00 0
Activity Based Costing
5.33
(i) Prepare a Statement showing allocation of manufacturing overheads using the principles of activity-based costing. (ii) Prepare a Statement showing product cost profitability using activity-based costing. (iii) Should ABC Ltd. continue to emphasize the Royal model and phase out the Nova model ? Discuss. (4+4+2 = 10 marks)
Answer (a) (i) Statement Showing Allocation of Manufacturing Overheads Using Principles of Activity Based Costing. Cost Allocation Activity Center
Tracea ble cost Rs.
Cost allocatio n basis
Royal
Nova
Rs.
Rs.
Soldering
9,42,00 0
385:1185
2,31,0 00
7,11,0 00
Shipments
8,60,00 0
38:162
1,63,4 00
6,96,6 00
Quality control
12,40,0 00
213:562
3,40,8 00
8,99,2 00
Purchase orders
9,50,40 0
109980:8 0100
5,49,9 00
4,00,5 00
Machine lower
57,600
16:176
4,800
52,800
Machine set ups
7,50,00 0
14:16
3,50,0 00
4,00,0 00
16,39, 900
31,60, 100
48,00,0 00
Units sold
produced
Manufacturing Overheads Cost unit
and
4,000
22,0 00
per
Rs. 409.98
Rs. 143. 64
5.34
Cost Accounting
(ii) Statement Showing Product using Activity Based Costing
Cost and
Royal Per Unit Cost Rs.
Standard cost other than manufacturing OHs cost Manufacturing OHs using activity-based costing Cost Selling Price/unit Gross Margin / unit Gross Margin Selling & Adm. Expenses Net Income
Profitability
Nova Per Unit Cost Rs.
698
370
409.98 1,107.9 8 1,140 32.02 1,28,08 0 9,78,00 0 (8,49,9 20)
143.64 513.64 900 386.36 84,99,9 20 58,30,0 00 26,69,9 20
Total Rs.
86,28,0 00 68,08,0 00 18,20, 000
(iii) Novo Model should continue to be bread and butter product and Royal model should not be over-emphasized; rather it’s pricing is required to be corrected. Question 10 ABC Bank is examining the profitability of its Premier Account, a combined Savings and Cheque account. Depositors receive a 7% annual interest on their average deposit. ABC Bank earns an interest rate spread of 3% (the difference between the rate at which it lends money and rate it pays to depositors) by lending money for home loan purpose at 10%. The Premier Account allows depositors unlimited use of services such as deposits, withdrawals, cheque facility, and foreign currency drafts. Depositors with Premier Account balances of Rs. 50,000 or more receive unlimited free use of services. Depositors with minimum balance of less than Rs. 50,000 pay Rs. 1,000-a-month service fee for their Premier Account.
Activity Based Costing
5.35
ABC Bank recently conducted an activity-based costing study of its services. The use of these services in 2005-06 by three customers is as follows:
5.36
Cost Accounting
Activity - Based Cost Per Transac tion Deposits/withdraw al with teller
Deposits/withdraw al with automatic teller machine (ATM) Deposits/withdraw al on pre-arranged monthly basis
Account Usage Custome Custome r r X
Customer Z
Y
40
50
5
Rs. 40
10
20
16
Rs. 25
0
12
60
R s . 1 2 5
Bank written
Cheques
Rs. 400
9
3
2
Foreign drafts
Currency
Rs. 600
4
1
6
Inquiries about Account balance
Rs. 75
10
18
9
Rs. 55,000
Rs. 40,000
Rs. 12,50,000
Average Premier Account balance for 2005-06
Assume Customer X and Z always maintains a balance above Rs. 50,000, whereas Customer Y always has a balance below Rs. 50,000. Required:
Activity Based Costing
5.37
(i) Compute the 2005-06 profitability of the customers X, Y and Z Premier Account at ABC Bank. (ii) What evidence is there of cross-subsidisation among the three Premier Accounts? Why might ABC Bank worry about this Cross-subsidisation, if the Premier Account product offering is Profitable as a whole? (iii) What changes would you recommend for ABC Bank’s Premier Account?
5.38
Cost Accounting
Answer (i)
Customer Profitability Analysis
ABC Bank – Premier Account Activity
Activi ty based cost Rs.
Customers
X Rs.
Y Rs.
Z Rs.
Deposits/with drawal with teller
125
5,000 (40 × 125)
6,250 (40 × 125)
625 (5 × 125)
Deposits/with drawal with ATM
40
400 (10 × 40)
800 (20 × 40)
640 (16 × 40)
25
0 (0 × 25)
300 (12 × 25)
1,500 (60 × 25)
400
3,600 (9 × 400)
1,200 (3 × 400)
800 (2 × 400)
600
2,400 (4 × 600)
600 (1 × 600)
3,600 (6 × 600)
75
750 (10 × 75)
1,350 (18 × 75)
675 (9 × 75)
12,150
10,500
7,840
1,650 (3% × 55,000)
1,200 (3% × 40,000) 12,000
37,500 (3% × 12,50,000)
Deposits/with drawal on prearranged monthly basis Bank cheques written Foreign currency drafts Inquiries about Account balance Customer cost (A) Spread on Average balance maintained Service fee
3%
Rs. 1,000
Activity Based Costing
p.m. Customer benefit
1,650
13,200
5.39
37,500
Cost Accounting
5.40
Customers
Customer Profitability (Benefits – Costs)
X
Y
Z
Rs. (10,500)
Rs. 2,700
Rs. 29,660
(ii) Customer Z is most profitable and is cross-subsidising the most demanding customer X. Customer Y is paying for the services used, because of not being able to maintain minimum balance. No doubt, ‘Premier Account’ product offering is profitable as a whole, but the worry is of not finding customers like customer Z who will maintain a balance higher than the stipulated minimum. It appears, the minimum balance stipulated is inadequate considering the services availed by depositors in ‘Premium Account’. (iii) The changes suggested to ABC Bank’s ‘Premier Account’ are as follows: •
Increase the requirement of minimum balance from Rs. 50,000 to Rs. 1,00,000.
•
Charge for value added services like Foreign Currency Drafts.
•
Do not allow deposits/withdrawal below Rs. 10,000 at the teller. Only ATM machine withdrawal be allowed.
•
Inquiries about account balance to be entertained only through Phone Banking/ATM.
Question 12 ABC Ltd. Manufactures two types of machinery equipments Y and Z and applies/absorbs overheads on the basis of direct-labour hours. The budgeted overheads and direct-labour hours for the month of December, 2006 are Rs. 12,42,500 and 20,000 hours respectively. The information about Company’s products is as follows: Equipment
Equipment
Y
Z
Budgeted Production volume
2,500 units
3,125 units
Direct material cost
Rs. 300 per unit
Rs. 450 per unit
Activity Based Costing
5.41
Direct labour cost Y : 3 hours @ Rs. 150 per hour X : 4 hours @ Rs. 150 per hour
Rs. 450
Rs. 600
ABC Ltd.’s overheads of Rs. 12,42,500 can be identified with three major activities:
5.42
Cost Accounting
Order Processing (Rs. 2,10,000), machine processing (Rs. 8,75,000), and product inspection (Rs. 1,57,500). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. The data relevant to these activities is as follows:
Y Z Total
Orders processed 350 250 600
Machine hours worked 23,000 27,000 50,000
Inspection hours 4,000 11,000 15,000
Required: (i) Assuming use of direct-labour hours to absorb/apply overheads to production, compute the unit manufacturing cost of the equipments Y and Z, if the budgeted manufacturing volume is attained. (ii) Assuming use of activity-based costing, compute the unit manufacturing costs of the equipments Y and Z, if the budgeted manufacturing volume is achieved. (iii) ABC Ltd.’s selling prices are based heavily on cost. By using direct-labour hours as an application base, calculate the amount of cost distortion (under-costed or over-costed) for each equipment. (iv) Discuss, how an activity-based costing might benefit ABC Ltd .
Answer (i) Overheads application base: Direct labour hours Equipment Y Rs. 300 450 186.38 936.38
Direct material cost Direct labour cost Overheads*
*Pre-determined rate =
Budgeted overheads Budgeteddirect labour hours
Equipme nt Z Rs. 450 600 248.50 1,298.50
Activity Based Costing
=
Rs.12,42,500 20,000hours
=Rs. 62.125
5.43
5.44
Cost Accounting
(ii) Estimation of Cost-Driver rate Activity
Order processing
Overhead cost Rs. 2,10,000
Machine processing Inspection
8,75,000
1,57,500
Cost-driver level
600 Orders processed 50,000 Machine hours 15,000 Inspection hours
Cost driver rate Rs. 350
17.50
10.50
Equipmen Equipment t Y
Z
Rs.
Rs.
Direct material cost
300
450
Direct labour cost
450
600
Prime cost
750
1,050
Order processing 350 : 250
1,22,500
87,500
Machine processing 23,000 : 27,000
4,02,500
4,72,500
42,000
1,15,500
Overhead cost
Inspection 4,000 : 11,000 Total overhead cost
5,67,000
6,75,500
Per unit cost
= 5,67,000/2,500
226.80
Rs. 216.16
Rs. 976.80
Rs. 1,266.16
= 6,75,500/3,125 Unit manufacturing cost (iii) Equipmen Equipment t
Activity Based Costing
Y
Unit manufacturing cost–using direct labour hours as an application base
5.45
Z
Rs.
Rs.
936.38
Rs. 1,298.50
5.46
Cost Accounting
Unit manufacturing cost–using activity based costing Cost distortion
976.80
Rs. 1,266.16
(–)40.42
(+)32.34
Low volume product Y is under-costed and high volume product Z is over-costed using direct labour hours as a basis for overheads absorption. It is due to the limitation of traditional costing system. (iv)
Activity-based costing system is suitable in case of ABC Ltd because it is a multi-product company and overheads costs are substantial portion of total cost. The use of activity based costing will avoid cost distortion as ABC Ltd has a large proportion of non-unit-level activities such as orders processed and inspection hours.
Question 13 Explain briefly each of the following categories in Activity based Costing by giving at least two examples: (i) Unit level activities (ii) Batch level activities (iii) Product level activities (iv) Facility level activities. (May 2007, 8 Marks)
Answer (i) Unit level activities − The cost of some activities (mainly primary activities) are strongly co-related to the number of units produced. These activities are known as unit level activities. Examples are:
(a) The use of indirect materials. (b) Inspection or testing of every item produced or say every 100th item produced. (c) Indirect consumables. (ii) Batch level activities – The cost of some activities (mainly manufacturing support activities) are driven by the number
Activity Based Costing
5.47
of batches of units produced. These activities are known as Batch level activities. Examples are: (a) Material ordering. (b) Machine set up cost. (c) Inspection of products - like first item of every batch.
5.48
Cost Accounting
(iii) Product level activities – The cost of some activities are driven by the creation of a new product line and its maintenance. These activities are known as Product level activities. Examples are:
(a) Designing the product. (b) Producing parts to a certain specified limit. (c) Advertising products.
cost,
if advertisement is for
individual
(iv) Facility level activities – The cost of some activities cannot be related to a particular product line, instead they are related to maintaining the building and facilities. These activities are known as Facility level activities. Examples are:
(a) Maintenance of buildings. (b) Plant security. (c) Production manager’s salary. (d) Advertising campaigns promoting the company. Question 14 PQR Ltd. manufactures four products, namely A, B, C and D using the same plant and process. The following information relates to production period October, 2007: Product
A
B
C
D
Output in units
1440
1200
960
1008
Direct Materials
Rs. 42
Rs. 45
Rs. 40
Rs. 48
Direct Labour
Rs. 10
Rs. 9
Rs. 7
Rs. 8
4
3
2
1
Cost per unit:
Machine hours per unit
The four products are similar and are usually produced in production runs of 48 units per batch and are sold in batches of 24 units. Currently, the production overheads are absorbed using machine hour rate. The production overheads incurred by the company for the period October, 2007 are as follows: Rs. Machine department costs 1,26,000
Activity Based Costing
5.49
(rent, deprecation and supervision) Set-up Costs
40,000
Store receiving costs
30,000
Inspection
20,000
Material handling and dispatch
5,184
During the period October, 2007, the following cost drivers are to be used for allocation of overheads cost: Cost
Cost driver
Set-up Costs
Number of production runs (batches)
Stores receiving
Requisition raised
Inspection
Number of production runs (batches)
Material handling and dispatch
Orders executed
It is also determined that: (i) Machine department costs should be apportioned among setup, stores receiving and inspection activities in proportion of 4 : 3 : 2. (ii) The number of requisitions raised on stores are 50 for each product. The total number of material handling and dispatch orders executed during the period are 192 and each order being for a batch size of 24 units of product. Required: (i) Calculate the total cost of each product, if all overhead costs are absorbed on machine-hour rate basis. (ii) Calculate the total cost of each product using activitybased costing. (iii) Comment briefly on as to how an activity-based costing might benefit PQR Ltd. (November 2007, 11 Marks)
Answer 14 (i) Total Overhead = Rs. 1,26,000 + 40,000 + 30,000 + 20,000 + 5,184 = Rs. 2,21,184
Cost Accounting
5.50
Total machine hours = 1,440 1,008 × 1
×
4 + 1,200
3 + 960
×
×
2 +
= 5,760 + 3,600 + 1,920 + 1,008 = 12,288. ∴
2,21,184 = Rs. 18 12,288
Overhead recovery rate / M.H. =
Cost Statement when overheads are absorbed on machine hours rate basis
(Traditional Costing) Product
A
B
C
D
1,440
1,200
960
1,008
Direct material Rs.
42
45
40
48
Direct labour Rs.
10
9
7
8
2× 18 = 36
1× 18 = 18
Output in units Cost per unit:
Overhead (@ Rs.18) Rs.
4× 18 = 72
Total cost per unit Rs. (Material + Laour + overhead Total cost Rs. (Output in units Total cost per unit)
3
18 = 54
×
124
108
83
74
1,78,560
1,29,600
79,680
74,592
×
(ii) (1) Machine department costs of Rs. 1,26,000 to be apportioned to set-up cost, store receiving and inspection in 4 : 3 : 2 i.e. Rs. 56,000, Rs. 42,000 and Rs. 28,000 respectively.
(2) One production run = 48 units. Hence, the number of production runs of different products: A
=
1,440
1,200
960
48
48
48
= 30, B =
= 25, C =
= 20, D =
1,008 48
= 2 or total 96 runs.
(3) One batch order is of 24 units. So the number of batches of different products:
Activity Based Costing
A
=
1,440
1,200
960
24
24
24
= 60, B =
= 50, C =
5.51
= 40, D =
1,008 24
= 42 or total 192 batches. Computation of Cost driver rates
(4)
Activity Cost (Rs.)
Cost driver
Quantity
Set-up
40,000 + 56,000 = 96,000
No. of production run
96
Storereceivin g
30,000 + 42,000 = 72,000
Requisition raised
Inspecti on
20,000 + 28,000 = 48,000
No. of production run
Material handlin g
5,184
Activity
Orders executed (No. of batches)
50
×
Cost driver rate
Rs. 1,000 per production run
4= 200
Rs. 360 per requisition
96
Rs. 500 per production run
192
Rs. 27 per batch
5.52
Cost Accounting
(5)
Cost statement under Activity Based Costing: Product
Out-put in units Material
A
B
C
D
1,440
1,200
960
1,008
Rs.
Rs.
Rs.
Rs.
1,440 × 42 = 60,480
Labour
1,200 × 960 × 40 1,008 × 45 = 48 = 38,400 = 48,384 54,000
1,440 × 1,200 × 960 × 7 10 9 = 6,720 = 14,400 = 10,800
1,008
×
8 = 8,064
Overhead cost: Set up
1,000 × 30 = 30,000
Store receiving 360
×
Inspection
×
1,000 × 25 = 25,000
1,000 × 20 = 20,000
1,000 × 21 = 21,000
50 360 × 50 360 × 50 360 × 50 = = = = 18,000 18,000 18,000 18,000
Material handling
Total cost Total cost per unit, (Total cost / Output)
Overhead cost per unit under
30 500 × 25 500 × 20 500 × 21 = = = 15,000 12,500 = 10,000 10,500
27 × 60 = 1,620
Total overhead cost
(iii) differences
500
27 × 50 27 × 40 27 × 42 = 1,350 = 1,080 = 1,134
64,620
56,850
49,080
50,634
1,39,500 1,21,650
94,200 1,07,082
96.875 101.375
98.125 106.232
Comparison (Rs. 18 × 4 machine hours) 72.00
of
(Rs. 18 × 3 machine hours) 54.00
Overhead (Rs. 18 × 2 machine hours)
cost
(Rs. 18 × 1 machine
Activity Based Costing
Traditional Absorption Costing system Overhead cost under Activity Based Costing system
36.00
64,620 1,440
Overhead Cost difference Overhead difference due to absorption system
44.8
=
56,850 1,200
27.125
37.68%
−
over cost
47.3
=
5.53
hour) 18.00
50,634 49,080 =51 1,008 960
6.625
(15.125)
(32.232)
12.27%
+42.10%
over cost
under cost
+179.07 %
−
under cost
Comments:
(i) There is a wide difference between the overhead cost as traced by the two systems. ABC is a superior method of tracing overhead costs since it relates the overhead costs with activities and resources consumed rather than just the machine hours rate. (ii) Products A and B have been over costed under absorption costing since machine hours per unit are higher than that of products C and D. Question 15 XYZ Ltd. produces and sells sophisticated glass items – ‘A’ and ‘B’. In connection with both the products the following informations are revealed from the cost records for the month February, 2008: Product Output (in units)
A 60,000
B 15,000
5.54
Cost Accounting
Sales (Rs.)
37,80,000
20,55,000
Direct material (Rs. per unit)
18.75
45.00
Direct Wages (Rs. per unit)
10.00
13.00
30,000 hours
9,750 hours
240
50
2 hours
5 hours
Cost structure:
Direct labour hours No. of quantity produced per batch Setup time per batch
The Indirect costs for the month are as under: Cleaning and maintenance wages
Rs. 2,70,000
Designing Costs
4,50,000
Set up costs
3,00,000
Manufacturing operation’s costs
6,37,500
Shipment costs
81,000
Distribution costs
3,91,500
Factory administration costs
2,55,000
At present the company adopts the policy to absorb indirect costs applying direct labour hour basis and enjoying a good position in the market with regard to Product B, but facing a stiff price competition with regard to Product A. The cost Accountant of the company, after making a rigorous analysis of the data, decided to shift from the absorption technique based on direct labour hours to activity cost driver basis and also to treat cleaning and maintenance wages as direct cost. The cost accountant identified Rs. 1,20,000 for product A and the balance of cleaning and maintenance wages for Product B. The data relevant to activities and products are as follows: Product Activity
Cost driver
Designing:
Square feet
Manufacturing operation’s:
Moulding machine hours
A
Product B
30 sq. ft.
70 sq. ft.
9,000 hrs.
3,750 hrs.
Activity Based Costing
Shipment:
Number Shipments
of
Distribution:
Cubic feet
Setup of moulding
Setup hours
5.55
100
100
45,000 cu. ft.
22,500 cu. ft.
machine: Factory administration:
Direct hours
labour
You are required: (i) to compute the total manufacturing cost and profits of both the products by applying direct labour basis of absorption, assuming cleaning and maintenance cost as indirect, (ii) to compute the total manufacturing cost and profits of both the products by applying activity based costing, assuming cleaning and maintenance cost as indirect (iii) to compare the results obtained from (i) and (ii) and give your opinion on the decision of cost accountant. (May 2008, 10 Marks)
Answer15 (a) Working: Calculation of Direct Labour hours: Rs.
Total Indirect Costs (Rs.)*
23,85,000
Total Direct labour hours (30,000 + 9,750)
39,750 Rs. 23,85,000 39,750hours
Overhead absorption rate
Rs. 60per hour
=
(i) Statement showing total manufacturing costs and profits Product A
Product B
(60,000 units)
Direct materials
(15,000 units)
Per unit
Amount (Rs.)
Per unit
Amount (Rs.)
18.75
11,25,000
45.00
6,75,000
Total (Rs.)
18,00,00 0
5.56
Cost Accounting
Direct labour
10.00
6,00,000
13.00
1,95,000
7,95,000
Prime cost
28.75
17,25,000
58.00
8,70,000
25,95,00 0
Indirect costs (absorbed on the basis of direct labour hours)
30.00
18,00,000
39.00
5,85,000
(18,00,0 00/
(30,000 hours @ Rs. 60 per hour)
(5,85,00 0/
(9,750 hours @ Rs. 60 per hour)
23,85,00 0
60,000 units)
15,000 units)
Total cost
58.75
35,25,000
97.00
14,55,000
49,80,00 0
Sales
63.00
37,80,000
137.00
20,55,000
58,35,00 0
4.25
2,55,000
40.00
6,00,000
8,55,000
Profit (Sales – Total cost)
* Calculation of total Indirect Cost: Rs.
Cleaning and maintenance wages
2,70,000
Designing costs
4,50,000
Set-up costs
3,00,000
Manufacturing operations cost
6,37,500
Shipment costs
81,000
Distribution costs
3,91,500
Factory Administration Costs
2,55,000 23,85,000
Indirect cost allocation to products A and B: Product A Direct labour hours Direct labour hour rate:
30,000 Rs.
Product B 9,750
60 60
Activity Based Costing
Indirect costs
5.57
Rs. 18,00,000
5,85,00 0
60,000
15,000
Output (units) Cost per unit of output
39
Rs. 30
Statement showing the total manufacturing costs and profits using direct labour hour basis of absorption and treating cleaning and maintenance cost as indirect cost: Product A Rs./u nit Output (units)
Product B
Amoun t
Rs./uni t
60,000
Total
Amoun t 15,000
Rs.
Rs.
Rs.
Sales
63.00
37,80, 000
137.00
20,55, 000
58,35,00 0
Direct Materials
18.75
11,25, 000
45.00
6,75,0 00
18,00,00 0
Direct Labour
10.00
6,00,0 00
13.00
1,95,0 00
7,95,000
Prime Cost
28.75
17,25, 000
58.00
8,70,0 00
25,95,00 0
Indirect costs
30.00
18,00, 000
39.00
5,85,0 00
23,85,00 0
Total costs
58.75
35,25, 000
97.00
14,55, 000
49,80,00 0
4.25
2,55,0 00
40.00
6,00,0 00
8,55,000
Profit (ii)
Calculation of Setup hours
Total Output (in units) No. of quantity produced per batch Setup time per batch
Product A
Product B
60,000
15,000
240
50
2 hours
5 hours
5.58
Cost Accounting
Setup hours (Total) (No. of batches × set up time per batch)
60,000×2 = 240
15,000×5 = 50
500
1,500
Activity Based Costing
5.37
Calculation of Cost Driver, Rates and summary of indirect cost relating to Product A & B: Activity and Cost Drivers
Amou nt (Rs.)
Cost Drivers for Product
A
Activity Cost Rates
Indirect Costs
(Amount / Product A total of cost driver)
B
Produ ct B
Cleaning & Maintenance (Direct Labour hours)
2,70,0 00
30,000
9,750
39,750
6.7925 per Direct labour hour
2, 03, 77 5
6 6, 227
Designing costs (square feet)
4,50,0 00
30 sq. feet
70 sq. feet
100
4,500 per sq. feet
1,35,000
3,15,0 00
Setup costs (setup hours)
3,00,0 00
500 hours
1,500 hours
2,000
150 per setup hour
75,000
2,25,0 00
Manufacturing operations costs (molding machine hours)
6,37,5 00
9,000
3,750
12,750
50 per molding hours
4,50,000
1,87,5 00
Shipment costs (No. of shipments)
81,000
100
100
200
405 per shipment
40,500
40,500
Distribution costs (area in cubic feet)
3,91,5 00
6 7, 500 22,500 cubic feet
5. 80 pe r cu bi c feet
2,61,000
45,000 cubic feet
1,30,5 00
Factory
2,55,0
30,000
9,750
39,750
6.4151 per
1,92,453
62,547
13,57,72 8
10,27, 274
60,000
15,000
22.63
68.48
5.38
Cost Accounting
administration costs (direct labour hours) Production (units)
00
labour hour
5.38
Cost Accounting
administration costs (direct labour hours)
00
labour hour
Production (units)
5.38
13,57,72 8
10,27, 274
60,000
15,000
22.63
68.48
Cost Accounting
Cost Sheet based on activity based costing system:
Description
Product A
Product B
Total cost
Per unit
Total cost
Per unit
Rs.
Rs.
Rs.
Rs.
37,80,00 0
63.00
20,55,00 0
137.00
Direct Materials
11,25,00 0
18.75
6,75,000
45.00
Direct Labour
6,00,000
10.00
1,95,000
13.00
Total
17,25,00 0
28.75
8,70,000
58.00
Indirect costs
13,57,72 8
22.63
10,27,27 4
68.48
Total costs
30,82,72 8
51.38
18,97,27 4
126.48
Sales Direct Cost
Cost Accounting
5.38
Cost Sheet based on activity based costing system:
Description
Product A
Product B
Total cost
Per unit
Total cost
Per unit
Rs.
Rs.
Rs.
Rs.
37,80,00 0
63.00
20,55,00 0
137.00
Direct Materials
11,25,00 0
18.75
6,75,000
45.00
Direct Labour
6,00,000
10.00
1,95,000
13.00
Total
17,25,00 0
28.75
8,70,000
58.00
Indirect costs
13,57,72 8
22.63
10,27,27 4
68.48
Total costs
30,82,72 8
51.38
18,97,27 4
126.48
Profit
6,97,272
11.62
1,57,726
10.52
Sales Direct Cost
(iii)
Comparison of results:
Description
Product A
Traditio nal Costing System
Product B
Activit Traditio y nal Based Costing System System
Activit y Based System
Rs.
Rs.
Rs.
Rs.
Selling Price
63.00
63.00
137.00
137.00
Direct costs
28.75
28.75
58.00
58.00
Indirect costs
30.00
22.63
39.00
68.48
Total cost per unit
58.75
51.38
97.00
126.48
Profit per unit
4.25
11.62
40.00
10.52
Opinion:
In the traditional costing system, Product B appears to be more profitable than Product A whereas under the activity
Activity Based Costing
5.39
based costing system, Product A appears to be more profitable than product B. The activities like designing, set up, manufacturing operation cost, shipment and distribution are support service activities and the consumption of resources relating to these activities are not dependent on direct labour hours. The quantum of consumption of resource of each support service activity is different in respect of the two products manufactured and hence activity based costing presents a true view of cost of production. Moreover, the suggestion to treat cleaning and maintenance activity as a direct cost pool is commendable because costs should be charged direct wherever possible. The results reveal that the company should concentrate upon product B. Alternative Solution:
Cleaning and maintenance activity will not find a place in the statement of calculation of cost driver rates. However, other cost driver rates will be unchanged. Statement showing total cost and profits on the basis of Activity Based Costing
Product A
Product B
Total (Rs.)
Per unit
Amoun t (Rs.)
Per unit
Amoun t (Rs.)
Direct materials
18.75
11,25, 000
45.00
6,75,0 00
18,00, 000
Direct labour
10.00
6,00,0 00
13.00
1,95,0 00
7,95,0 00
Cleaning & maintenance expenses
2.00
1,20,0 00*
10.00
1,50,0 00*
2,70,0 00
30.75
18,45, 000
68.00
10,20, 000
28,65, 000
Designing
2.25
1,35,0 00
21.00
3,15,0 00
4,50,0 00
Setup
1.25
75,000
15.00
2,25,0 00
3,00,0 00
Manufacturing operation
7.50
4,50,0 00
12.50
1,87,5 00
6,37,5 00
Prime cost Indirect costs:
Cost Accounting
5.40
Shipments
0.67
40,500
2.70
40,500
81,000
Distribution
4.35
2,61,0 00
8.70
1,30,5 00
3,91,5 00
Factory administration
3.21
1,92,4 53
4.17
62,547
2,55,0 00
19.23
11,53, 953
64.07
9,61,0 47
21,15, 000
49.98
29,98, 953
132.0 7
19,81, 047
49,80, 000
63.00
37,80, 000
137.0 0
20,55, 000
58,35, 000
13.23
7,81,0 47
4.93
74,953
8,55,0 00
Total indirect costs Total costs Sales Profits (Sales – total costs)
*
The Cost Accountant identified Rs. 1,20,000 for Product A and balance Rs. 1,50,000 of cleaning and maintenance wages for Product B.