Activity Based Costing - Govt.college for girls sector 11 ...

Activity Based Costing - Govt.college for girls sector 11 ...

Activity Based Costing What? Why? How? Requirement of Cost Systems Valuation of inventory and measurement of the cost of goods sold for financial reporting. Estimation of the costs of activities, products, services, and customers. Providing economic feedback to managers and operators about process efficiency. 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 Composition of Cost 100

0 1 Direct Material 2 3 Labour Overheads 4 Conventional Costing Total Cost = Material + Labour+ Overheads Overheads are allocated to the products on volume based measures e.g. labour hours, machine hours, units produced Will this not distort the costing in the new environment? ABC provides an Alternative. Conventional Costing Expenses

AB Costing Economic Element Resources Activities Work Performed Cost Objects Product or service Cost Objects 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? Basics of A B C : How? Cost pools are groups or categories of individual expense items 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: Activity Dictionary Move material

Respond to customers Schedule production Purchase material Inspect items 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

Activities Business Development ABC Records Salaries DepreciationElectricity Supplies Travel 20,000 25000 5000 5000 Total 55,000 Depreciation 155,000 Maintianing Present Business 80,000 60000 50000

5000 10000 205,000 Electricity 132,000 Purhcasing Material 125,000 50000 20000 20000 60000 275,000 Supplies 25,000

Set up Machines 25,000 10000 2000 37,000 Travel 100,000 Running Machines 50,000 10000 50000 110,000 Total

725,000 Resolve Quality Problems 13,000 Total 313,000 155000 132000 5000 25000 43,000 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 activity drivers The linkage between activities and cost objects, such as products, customers,, is accomplished by using activity drivers. 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. Activities Drivers Unit Level Acquire and Use material for containers No. of Containers Acquire and Use material for baby-care products No. of products Batch Level

Set up manually controlled machines Set up computer controlled machines No. of batches of contain No. of batches of B. Prod Product Level Design and manufacture moulds Use manually controlled machines Use conputer controlled machines No.of moulds required Product type (containers) Product type (B.Products Customer Level Consult customers Provide warehousing for customers No. of consultations No. of cubit feet Faciltiy Level Manage workers

Salaries Activities Drivers Unit Level Acquire and Use material for containers No. of Containers Acquire and Use material for baby-care products No. of products Batch Level Set up manually controlled machines No. of batches of containers Set up computer controlled machines No. of batches of B. Produst Activity Cost Activity VolumeActivity Rate 40,000 80,000 1,000,000 8,000 0.04 10 3,000 12,000 10

20 300 600 5,000 15,000 40,000 5 1 1 1000 15000 40000 4,000 2,000 40 10,000 100 0.2

3,000 48,000 15,000 16,000 0.2 3 Product Level Design and manufacture moulds No.of moulds required Use manually controlled machines Product type (containers) Use conputer controlled machines Product type (B.Products) Customer Level Consult customers No. of consultations Provide warehousing for customers No. of cubit feet Faciltiy Level Manage workers Salaries Use main building Square feet Ascertaining Cost Activities A. Rate A.Volume

Containers Baby Product Unit Level Acquire and Use material for containers 0.04 1,200,000 48,000 Acquire and Use material for baby-care products 10 7,000 70000 Batch Level Set up manually controlled machines Set up computer controlled machines 300 600 12 16 3,600 1 4

1 1 1,000 9600 Product Level Design and manufacture moulds Use manually controlled machines Use conputer controlled machines 1000 15000 40000 4000 15,000 40000 Customer Level Consult customers Containers

B.products Provide warehousing for customers Containers B.products Faciltiy Level Manage workers Containers B.products Use main building Containers B.products Total Cost 100 2 40 200 8,000 2,000 1,600 4,000

10,000 800 5,000 7,000 15,000 4000 0.2 400 0.2 2000 3 85,200 21000 151,000 Building an ABC Model

Identify Resources Identify Activities Define Resource Drivers Define Activity Drivers Enter Resource Costs Enter Resource Driver Qty. Identify Cost Objects

Enter Activity Driver Qty. Calculate Costs ABC: Where to Use? High Overheads Product Diversity or Multiple Products Customer Diversity Service Diversity Stiff Competition

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