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# Activity Based Costing

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A revision presentation for Advanced Management Acounting exam of Coventry University

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### Activity Based Costing

1. 1. KISS By Ahmed A. Zaidi, CMA
2. 2. Sharing a Lunch  3 friends eat out at a restaurant  They order 1. chicken platter : \$20 (cost pool 1) 2. salad : \$7 (cost pool 2).  How should cost be split up  Equally?!
3. 3. Activity = eating  The fitness freak (F) munches only salad (2/3)  The glutton gorges (G) only chicken (2/3)  The in-between (I) eats both (1/3 x both) How should the cost be allocated fairly? G (2/3 x 20= \$13.33) F (2/3 x 7= \$4.67) I (1/3 x 20 +1/3x7 = 6.67+2.33= \$9)
4. 4. A Free Lunch?!  Cross- subsidization – paying somebody else’s cost  Someone is under-costed and over-costed  Under-costed G (13.33-7=\$6.33)  Over-costed F (7-4.67=\$2.33)  Solution: ABC – costing according to activity  Activity  cost
5. 5. ABC problems  Keeping activity records ((counting mouthfuls -Cost Driver ?!!)  Identifying the cost drivers (cause & effect relationship)  More than one cost pool  More than one cost driver
6. 6. CU© Exam Practice –Resit 2014 Q  Kevin and Ernie Ltd - road construction company  Uses DL £ to absorb overheads- Profit Markup 60%  Cost of labour of job £600,000  Current annual budget as follows £000s Sales Revenue 125,000 Direct Materials 30,000 Direct Labour 60,000 Overhead Costs 20,000 Operating Income 15,000
7. 7. Absorption Costing  Step 1: Calculate the Overhead Absorption Rate (OAR)  OAR= Total Overhead cost/ Total Direct Labor (DL)  Step 2: Multiply OAR by the DL cost of the job Job Overhead absorbed = 0.33 x £600,000= £200,000  Step 3: Add Direct costs and Profit to get Selling Price OAR £ total overhead costs 20,000,000 total direct labor cost 60,000,000 OAR 0.33 Direct Labour cost 600,000 Overhead Cost 200,000 Total Abs cost 800,000 mark up (0.6x 800,000) 480,000 Total Abs price 1,280,000
8. 8. ABC  Step1: Calculate each activity overheads & Cost Driver Rate CDR = Activity Cost Pool/ Cost Driver used Total Overheads Total co CDR 20,000,000 Specialist equip hire 0.45 9,000,000 8,000 £1125/ day Agency labour 0.25 5,000,000 20000 £250/ hr Insurance 0.15 3,000,000 300 £10000/ employee Admin support 0.1 2,000,000 5000 £400/ hr Surveyor 0.05 1,000,000 1000 £1000/hr 20,000,000
9. 9. ABC (Contd)  Step 2: Apply the CDR to cost drivers used in this job  CDR xCost driver used in road= Overhea absorbed CDR CDR CDR used road Total Specialist equip hire 1125 50 56,250 Agency labour 250 750 187,500 Insurance 10000 20 200,000 Admin support 400 125 50,000 Surveyor 1000 6 6,000 499,750
10. 10. ABC (Contd) ABC Overhead cost 499,750 Direct Labor 600,000 Total ABC cost 1,099,750 Mark up (60% x 1099,750) 659,850 Total ABC Selling Price 1,759,600  Step 3: Add ABC Overhead cost to DL to get Total ABC Cost. Then apply markup % to calulate ABC price  Calculate the difference between Absorption & ABC SP  The contract is being under-costed by £479,600 by Absorption costing compared to ABC  Compare it with cost of ABC recordkeeping & analysis
11. 11. ABM Benefits Source: assignmentpoint.com