L7.pdf statistical approcah help to guide you
- 1. Activity Based Costing(ABC) Activity Based costing is a method of costing that allocates overhead costs to product based on the activity (Cost driver) such as ordering, materials handling , deliveries and machine set up. The traditional method of allocating overhead costs allocates costs based on volume of production or labor hour. mrdi(EWU)
- 2. Traditional Absorption Costing Vs.ABC costing Traditional Absorption Costing is designed to provide data for external financial reports . Whereas ,ABC is designed to be used for internal decision making. In traditional absorption costing overheads are first related to cost centre's and then to cost objects(products).On the other hand ABC system allocates overhead based on activities or cost pools Activity based costing provide best results where the overheads are huge amounts. mrdi(EWU)
- 3. Stages in ABC calculations Group overheads into cost pools ; according to how they are driven Identify the cost driver for each activity(that is what causes the activity to be incurred) Calculate a cost per unit of cost driver Cost Driver Rate=Total cost of activity Cost driver Absorb activity costs into production based on the usage of cost drivers-for example , rate per production set up multiplied by number of production set ups. mrdi(EWU)
- 4. Cost Drivers and Cost Pools Cost driver is a factor that influence the level of cost . For example ,the number of purchase orders would be a cost driver for procurement cost. All of the costs associated with a particular cost driver would be grouped into cost pools. mrdi(EWU)
- 5. Examples of cost driver Support Department Costs Possible Cost Driver 1.Set Up costs Number of production units 2.Production Scheduling Number of production runs 3.Materials Handling Number of Production runs 4.Inspection costs Number of Inspections or inspection Hours 5.Raw Materials inventory Handling etc. Number of purchase orders delivered 6.Despatch costs Number of customer orders delivered 7.Service Customers Number of orders mrdi(EWU)
- 6. ABC Example: Stars Ltd (a) Stars Ltd makes and sells two products: product A (complex design) and product B (standard design). Cost information for these products is as follows: A B Volume (units) Selling price Direct Labour @ £10 per hour Direct materials cost per unit 5,000 £120 £30 £25 20,000 £90 £20 £15 mrdi(EWU) Total overhead cost = £880,000 Total direct labour hours 15,000 40,000 55,000 Overhead absorption rate £16/DLH Overhead cost per unit 16x3 £48 £32 16x2 Prime cost (DL+DM) £55 £35 Total cost per unit £103 £67
- 7. ABC Example: Stars Ltd (b) Activity Overhead Cost Cost Driver Information A B £ Machine set-up 235,000 5,000 set ups 3,000 2,000 Quality inspection 160,000 8,000 inspections 5,000 3,000 Production orders 81,000 600 orders 200 400 Machine time 314,000 40,000 hours 12,000 28,000 Materials receipts 90,000 750 receipts 150 600 880,000 mrdi(EWU)
- 8. Calculating overhead costs using ABC Activity Cost £ Cost Drivers Cost per unit of cost driver Machine set-up 235,000 5,000 set ups £47 / set up Quality inspection 160,000 8,000 inspections £20 / inspec. Prod. orders 81,000 600 orders £135 / order Machine time 314,000 40,000 hours £ 7.85 /hour Materials receipts 90,000 750 receipts £120 / receipt Total 880,000 mrdi(EWU)
- 9. Calculating product costs using ABC A(5,000 Units) B(20,000 Units) Overhead cost: Total £ PerUnit £ Total £ PerUnit £ M/ne set-up @ £47 141,000 28.20 94,000 4.70 Quality insp.@ £20 100,000 20.00 60,000 3.00 Prod. orders@£135 27,000 5.40 54,000 2.70 Machine time@£7.85 94,200 18.84 219,800 10.99 Mat.receipts @£120 18,000 3.60 72,000 3.60 Total overhead cost 380,200 76.04 499,800 24.99 Prime cost (DL+DM) 275,000 55.00 700,000 35.00 Total cost 655,200 131.04 1,199,800 59.99 mrdi(EWU)
- 10. Comparison of product cost results: A B Overhead cost: £ % £ % Traditional costing 48.00 32.00 ABC 76.04 24.99 Difference + 28.04 + 58.42% - 7.01 -21.91% Total unit cost: Traditional costing 103.00 67.00 ABC 131.04 59.99 difference + 28.04 + 27.22% - 7.01 -10.46% Class activity 1: Determine the implications of the cost differences on each product’s profit and price. mrdi(EWU)
- 11. Comparison of product cost results: A B Overhead cost: £ % £ % Traditional costing 48.00 32.00 ABC 76.04 24.99 Difference + 28.04 + 58.42% - 7.01 -21.91% mrdi(EWU) Total unit cost: Traditional costing 103.00 67.00 ABC 131.04 59.99 difference + 28.04 + 27.22% - 7.01 -10.46% Class activity 1: Determine the implications of the cost differences on each product’s profit and price.
- 12. Some Limitations of ABC • Causal relationships not always clearly determinable Facility-level costs allocated arbitrarily • High measurement and implementation costs cost-benefit • Possible behavioural implications • Overall, ABC is not a panacea. mrdi(EWU)
- 13. Class Activity 2 Get into small groups and discuss what steps you think you should follow to introduce an ABC system to your company. Write down your ideas and designate a person in your group to read them out when the tutor asks each group to do so. mrdi(EWU)