Post on 26-May-2015
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04/12/23 VACA 1
CA.Chandra Sekhar VeeraghantaCA.Chandra Sekhar Veeraghanta
A B C A B C Activity Based Activity Based
CostingCosting
04/12/23 VACA 2
ABC Concepts What is ABC ?
Inventory Valuation method ? Yes, if it replaces traditional full absorption/ variable
costing method Resource Consumption Decision Support
Model ? Yes, provides info about how & why resources are
consumed Cost Accumulation Method ?
Does not replace job order costing & process costing but, enhances the accuracy of product costs
04/12/23 VACA 3
Problems with Traditional Systems
Product Cost Distortions O/H allocation based on production volume
while the consumption of resources is not in proportion to volume of products produced.
Excluding Non-Manufacturing Costs Product related Design, Admin, Selling &
Distribution, Customer Service costs are not traced to inventory
04/12/23 VACA 4
Causes for Product Cost Distortions Product Volume Diversity
Low Volume product receives low O/H High Volume product receives high O/H Both products require Engg., Purchase, etc support
irrespective of number of units produced.
Product Diversity Small products require less production volume related
inputs – such as direct labour; but, may not necessarily mean less on support.
Small product – design complexity, longer setup hrs etc
04/12/23 VACA 5
SUMMARY OF COST DISTORTIONSTHAT TEND TO OCCUR IN TRADITIONAL COST SYSTEMS
TYPE OF DIVERSITY
PRODUCT TYPE OR CHARACTERISTIC
TYPE OF COST DISTORTION THAT TENDS TO OCCUR IN
TRADITIONAL COST SYSTEMS
Production volume Low Volume specialty Undercost, i.e., too little overhead is allocated to these products.
High Volume main line Overcost, i.e., too much overhead is allocated to these products.
Product Size Small Undercost
Large Overcost
Product Complexity Complex design Undercost
Simple design Overcost
Product Materials requirements
Requires many, or unique parts, i.e., only used on a single product.
Undercost
Requires few, or common parts, i.e., same part used on many products.
Overcost
Product Machine setup requirements
Requires many, long or complex machine setups.
Undercost
Requires few, short or simple machine setups.
Overcost
04/12/23 VACA 6
The Logic of ABC
Designing, Producing & Distribution of Products/ service requires – activities to be performed.
Performing these activities requires resources – to be purchased & used
Using Resources - costs
04/12/23 VACA 7
The Logic of ABC
Restate in reverse order :
Resources generate costs
Activities consume resources
Products consume activities
04/12/23 VACA 8
The Logic of ABC
04/12/23 VACA 9
The Logic of ABC
Company’s activities are identified Costs are traced to these activities ( or activity cost pools ) based on the resources they require Costs are traced / assigned from each of these activity cost pools to the products / services in proportion to the demands that each product places on each activity.
04/12/23 VACA 10
ACTIVITY VOLUME – ACTIVITY MEASURES
Activity Volume refers to an input or output measurement of the quantity of the work performed to accomplish an activity.
These measurements may represent the frequency, duration, or physical volume of an activity
ABC uses both production volume and non-production volume activity measures to trace costs
04/12/23 VACA 11
EXAMPLES OF ACTIVITY COST POOLS AND ACTIVITY MEASURES
ACTIVITY COST POOL POTENTIALLY USEFUL ACTIVITY MEASURES
PROBABLE COST CLASSIFICATION*
Machining parts Number of machine hours. Unit level.
Purchasing Number of purchase orders or ordering hours.
Product or batch level.
Receiving and Storing Number of purchase orders or shipments received.
Product or batch level.
Engineering Number of engineering work orders or hours.
Product level.
Packing Number of shipments, number of cubic feet or packing hours.
Product or batch level.
Shipping Number of pounds shipped. Product or batch level.
Machine Setup Number of setups or setup time. Batch level.
Materials handling Number of times handled or material handling hours.
Product or batch level.
Inventory control and materials planning Number of part numbers or administrative hours.
Product or batch level.
Inspection and quality control Number of inspections or inspections time. Product or batch level.
04/12/23 VACA 12
ABC COST HIERARCHY A cost classification scheme which places
all costs into one of the following categories : Unit level – the cost of an activity required
once each time a unit of product is produced. Batch level – the cost of an activity required
each time a batch of products is produced. Product level – the cost of an activity required
to support a specific type of product.
…
04/12/23 VACA 13
ABC COST HIERARCHY A cost classification scheme which places
all costs into one of the following categories : … Facility Level – the cost of an activity
associated with maintaining the facility or plant Customer level – the cost of an activity
required to support a specific customer
04/12/23 VACA 14
Activities – Drivers - Measures
Activities : Types of work performed – purchasing, designing etc
Cost and Activity Drivers : Underlying cause for the cost
Activity Measure : A unit of measurement chosen to represent the activity volume
04/12/23 VACA 15
ABC CONCEPTS AND TERMINOLOGY
Activities - A type of work or function.
Type Definition Examples
Main activitiesA major type of work, function or high level activity.
Purchasing raw materials.
Sub activitiesA lower level type of work, or activity that supports a main activity.
Preparing purchased orders.
TasksA minor type of work that supports a sub activity.
Calling vendors.
Sub tasks Part of a task.Dialing a vendor's phone number.
04/12/23 VACA 16
ABC CONCEPTS AND TERMINOLOGY
Drivers - Whatever causes the need for activities to be performed.
Type Definition Examples
Primary drivers
The initial cause of an activity that requires resources, i.e., whatever creates the demand for an activity.
Company's overall objectives, customer demands and product specifications.
Secondary drivers
A resource consuming activity that is caused by a previous activity or event.
Purchasing raw materials, preparing purchase orders.
04/12/23 VACA 17
ABC CONCEPTS AND TERMINOLOGY
Activity measures - A unit of measure chosen to represent an activity volume.
Type Definition Examples
Frequency measures
The number of times an activity is performed.
Number of purchase orders, number of engineering work orders.
Duration measures
The time consumed performing the activity.
Ordering hours, engineering hours, machine hours.
Physical measures
The quantity of a resource processed by an activity.
Cubic feet packed, pounds shipped.
04/12/23 VACA 18
ABC TECHNIQUE
FOUR STEPS IN DESIGNING AN ABC SYSTEM OR SUB-SYSTEM
1) identifying a company's main activities, 2) determining the primary and secondary
drivers for these activities, 3) aggregating activities into homogenous
cost pools and 4) selecting activity measures to represent
each pool.
04/12/23 VACA 19
THREE STEPS TO OBTAIN ABC COSTSTHREE STEPS TO OBTAIN ABC COSTS
1) Calculate the activity overhead rates for each activity cost pool by dividing the total annual cost of each cost pool by the total annual quantity of the activity measure associated with each pool. More precisely in equation form:
Rj = Annual costs of activity j ÷ Annual quantity of activity j
where: Rj = the activity overhead rate for activity j.
j = the number of the activity.
04/12/23 VACA 20
THREE STEPS TO OBTAIN ABC COSTSTHREE STEPS TO OBTAIN ABC COSTS
2) Determine the total annual costs of each product by multiplying the activity overhead rates by the activity quantities associated with each product as follows,
Ci = Di + Σ (Rj)(Aji)where: Ci = Total annual cost of product i. Di = Direct cost of product i. Aji = Quantity of activity j consumed by product i. Rj = the activity overhead rate for activity j. j = the number of the activity. i = the number of the product. Σ = Sigma sign meaning "the sum of".
04/12/23 VACA 21
THREE STEPS TO OBTAIN ABC COSTSTHREE STEPS TO OBTAIN ABC COSTS
3) Calculate each product's unit costs by dividing the total annual costs for each product i by the number of units of product i produced.
ABC unit cost for product i = Ci ÷ Units of
product i.
04/12/23 VACA 22
EXAMPLEEXAMPLE ANNUAL PRODUCT DATA FOR COMPANY A
PRODUCT RELATED DATA V1 V2
Annual production quantity in unitsMaterial cost per unitDirect labour hours per unitDirect labour cost per hourNumber of purchase orders required per yearNumber of engineering work orders required per yearNumber of machine setups required per year
100 Rs.50
1Rs.10
142
1,000 Rs.50
1Rs.10
284
ANNUAL ACTIVITY COSTS FOR COMPANY A
ACTIVITYANNUALCOSTS ACTIVITY MEASURE
Purchasing and receivingEngineeringMachine setupMachining, power & maintenanceMaterials planning & handlingTotal factory overhead costs
Rs.24,00018,00024,60022,00011,000
Rs.99,600======
Number of purchase orders Number of engineering work orders Number of machine setups Number of direct labour hours Number of materials rupees
04/12/23 VACA 23
EXAMPLEEXAMPLE
ARE THERE ANY HOMOGENEOUS COST POOLS ? one for non-production volume related costs
and one for production volume related costs consumption proportions for the three non-
production related costs pools (purchasing/receiving, engineering and setups) are the same and
consumption proportions for the two production related cost pools (machining/power/maintenance, and materials planning/ handling) are the same
Combine the cost pools into a single homogeneous cost pool and trace to products
04/12/23 VACA 24
EXAMPLEEXAMPLE
ANNUAL ACTIVITY COSTS FOR COMPANY ACOMBINED HOMOGENEOUS COST POOLS
ACTIVITY POOL ANNUALCOSTS
ACTIVITY MEASURE
Non-production volume relatedProduction volume relatedTotal factory overhead costs
Rs.66,60033,000
Rs.99,600
Number of purchase orders Number of direct labour hours
04/12/23 VACA 25
Calculating ABC Costs for Company A
Step 1: Calculating Activity Overhead Rates Rj = Annual costs of activity j ÷ Annual quantity of activity j
1. Non-production volume related = Rs.66,600 ÷ 3* = Rs.22,200 per purchase order.* Total purchase orders = 1 for V1 and 2 for V2.
2. Production volume related = Rs.33,000 ÷ 1,100* = Rs.30 per direct labour hour.* Total direct labour hours = 100 for V1 and 1,000 for V2.
EXAMPLEEXAMPLE
04/12/23 VACA 26
EXAMPLEEXAMPLE COMPANY ACOSTS TRACED TO PRODUCTS V1 AND V2
USING AN ACTIVITY BASED COST (ABC) SYSTEM
COST POOL OR CATEGORY
ACTIVITY RATE MULTIPLIED BY
QUANTITY OF ACTIVITY MEASURE
(Rj)(Aji)
C1=COST
TRACED TO V1
ABC UNIT COST
V1*
C2=COST
TRACED TO V2
ABCUNIT COST
V2**
1. Non-production volume related:
(Rs.22,200)(1 PO)(Rs.22,200)(2 PO'S)
Rs.22,200 Rs.222.00Rs.44,400 Rs.44.40
2. Production volume related:
(Rs.30)(100 DLH)(Rs.30)(1,000 DLH)
3,000 Rs.30.0030,000 30.00
Total Overhead Rs.25,200 Rs.252.00 Rs.74,400 Rs.74.40
3. Direct Material: (Rs.50)(100)(Rs.50)(1,000)
5,000 50.0050,000 50.00
4. Direct Labour: (Rs.10)(1hr)(100)(Rs.10)(1hr)(1,000)
1,000 10.0010,000 10.00
Totals Rs.31,200=======
Rs.312.00======
Rs.134,400=======
Rs.134.40======
04/12/23 VACA 27
EXAMPLEEXAMPLECOMPANY A
COST TRACED TO PRODUCTS V1 AND V2 USING ATRADITIONAL PRODUCTION VOLUME BASED (PVB) COST SYSTEM
COST POOL OR
CATEGORY
ACTIVITY RATE MULTIPLIED BY
QUANTITY OF ACTIVITY MEASURE
COST ALLOCATED TO
V1
PVB UNIT COST
V1*
COST ALLOCATED TO
V2
PVB UNIT COST V2**
1.Non-production volume related:
(Rs.60.5455)(100DLH)(Rs.60.5455)(1,000)
Rs.6,054.55 Rs.60.55Rs.60,545.45 Rs.60.55
2. Production volume related:
(Rs.30)(100 DLH)(Rs.30)(1,000)
3,000.00 Rs.30.0030,000.00 30.00
Total Overhead Rs.9,054.55 Rs.90.55 Rs.90,545.45 Rs.90.55
3. Direct Material: (Rs.50)(100 units)(Rs.50)(1,000)
5,000.00 50.0050,000 50.00
4. Direct Labour: (Rs.10)(1hr)(100 units)(Rs.10)(1hr)(1,000)
1,000.00 10.0010,000 10.00
Totals Rs.15,054.55========
Rs.150.55======
Rs.150,545.45========
Rs.150.55======
04/12/23 VACA 28
EXAMPLEEXAMPLE
04/12/23 VACA 29
EXAMPLE 2EXAMPLE 2ANNUAL PRODUCT DATA FOR COMPANY B
PRODUCT RELATED DATA V2 V3
Annual production quantity in unitsMaterial cost per unitDirect labour hours per unit Direct labour cost per hourNumber of purchase orders requiredNumber of engineering work orders requiredNumber of machine setups required
1,000Rs.50
1Rs.10
284
1,000Rs.500
10Rs.10
284
04/12/23 VACA 30
EXAMPLE 2EXAMPLE 2ANNUAL ACTIVITY COSTS FOR COMPANY B
SEPARATE AND COMBINED HOMOGENEOUS COST POOLS
ACTIVITYANNUAL COSTS
ACTIVITY MEASURE
Purchasing and receiving EngineeringMachine setupNon-production volume related
Machining, power & maintenanceMaterials planning & handlingProduction volume relatedTotal factory overhead costs
Rs.32,000 24,00032,800
Rs.88,800
220,000110,000330,000
Rs.418,800=======
Number of purchase orders Number of engineering work orders Number of machine setups Number of purchase orders
Number of direct labour hours Number of materials rupees Number of direct labour hours
04/12/23 VACA 31
Calculating ABC Costs for Company B
Step 1: Calculating Activity Overhead Rates Rj = Annual costs of activity j ÷ Annual quantity of activity j
1. Non-production volume related = Rs.88,800 ÷ 4* = Rs.22,200 per purchase order.* Total purchase orders = 2 for V2 and 2 for V3.
2. Production volume related = Rs.330,000 ÷ 11,000* = Rs.30 per direct labour hour.* Total direct labour hours = 1,000 for V2 and 10,000 for V3.
EXAMPLE 2EXAMPLE 2
04/12/23 VACA 32
EXAMPLE 2EXAMPLE 2 COMPANY BCOST TRACED TO PRODUCTS V2 AND V3
USING AN ACTIVITY BASED COST (ABC) SYSTEM
COST POOL OR
CATEGORY
ACTIVITY RATE MULTIPLIED BY
QUANTITY OF ACTIVITY MEASURE (Rj)(Aji)
C2=COST TRACED TO
V2ABC UNIT COST V2*
C3=COST TRACED TO
V3
ABCUNIT COST
V3**
1. Non-production volume related:
(Rs.22,200)(2 PO'S)(Rs.22,200)(2 PO'S)
Rs.44,400 Rs.44.40Rs.44,400 Rs.44.40
2. Production volume related:
(Rs.30)(1,000 DLH)(Rs.30)(10,000 DLH)
30,000 Rs.30.00300,000 300.00
Total Overhead Rs.74,400 Rs.74.40 Rs.344,400 Rs.344.40
3. Direct Material: (Rs.50)(1,000 units)(Rs.500)(1,000 units)
50,000 50.00500,000 500.00
4. Direct Labour: (Rs.10)(1hr)(1,000)(Rs.10)(10hrS)(1,000)
10,000 10.00100,000 100.00
Totals Rs.134,400=======
Rs.134.40======
Rs.944,400=======
Rs.944.40======
04/12/23 VACA 33
EXAMPLE 2EXAMPLE 2COMPANY B
COST TRACED TO PRODUCTS V2 AND V3 USING ATRADITIONAL PRODUCTION VOLUME BASED (PVB) COST SYSTEM
COST POOL OR CATEGORY
ACTIVITY RATE MULTIPLIED BY QUANTITY OF
ACTIVITY MEASURE
COSTALLOCATED TO
V2PVB UNIT COST V2*
COST ALLOCATED TO
V3PVB UNIT COST V3**
1.Non-production volume related:
(Rs.8.0727)(1,000)(Rs.8.0727)(10,000)
Rs.8,072.70 Rs.8.07Rs.80,727.00 Rs.80.73
2. Production volume related:
(Rs.30)(1,000 DLH)(Rs.30)(10,000)
30,000.00 Rs.30.00300,000.00 300.00
Total Overhead Rs.38,072.70 Rs.38.07 Rs.380,727.00 Rs.380.73
3. Direct Material: (Rs.50)(1,000 units)(Rs.500)(1,000 units)
50,000.00 50.00500,000 500.00
4. Direct Labour: (Rs.10)(1hr)(1,000)(Rs.10)(10hrs)(1,000)
10,000.00 10.00100,000 100.00
Totals Rs.98,072.70========
Rs.98.07======
Rs.980,727========
Rs.980.73======
04/12/23 VACA 34
Thank youThank youThank youThank you