ABC Analysis of Cost analysysis and Indirect analysis Direct analysis

1. DOON BUSINESS SCHOOL
SELAQUI (DEHRADUN)
COURSE- MBA BASE
FRIDAY, 3RD APRIL 2020
SUMMARY REPORT
ON
NESTLE SA
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2. GROUP -8
• Name
• Shweta Kumari
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3. Executive Summary
• Activity-Based Costing (ABC) represents an alternative paradigm to traditional cost accounting system
and it often provides more accurate cost information for decision making such as product pricing,
product mix, and make-or buy decisions. ABC models the causal relationships between products and
the resources used in their production and traces the cost of products according to the activities
through the use of appropriate cost drivers.
•
• In this project, the costing system followed by NESTLE is compared with ABC in terms of the effects on
the product costs that are carried out to highlight the difference between two costing methodologies.
By using this methodology, a valuable insight into the factors that cause the cost is provided, helping
to better manage the activities of the company.
•
• According to the study, Nestle follows traditional method for costing that assign overheads directly to
the product. Cost of the product UC Range series 4 end cover is found out by Activity Based costing
and is compared with the traditional method followed by Nestle to arrive at the cost of the above
product. The study states that the product is being over cost by the company.
•
• Nestle should go for Activity Based Costing as it understands true profitability of the customers,
products or services and also helps in identifying areas where the cost can be reduced or efficiencies
can be increased
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4. Objectives of Report
• Nestlé's business objective is to manufacture and market the Company's products in such a
way as to create value that can be sustained over the long term for shareholders,
employees, consumers, and business partners.
• Nestlé does not favour short-term profit at the expense of successful long-term business
development.
• Nestlé recognizes that its consumers have a sincere and legitimate interest in the behaviour,
beliefs and actions of the Company behind brands in which they place their trust and that
without its consumers the Company would not exist. So the needs & wants of consumers
should be considered.
• Nestlé believes that, as a general rule, legislation is the most effective safeguard of
responsible conduct, although in certain areas, additional guidance to staff in the form of
voluntary business principles is beneficial in order to ensure that the highest standards are
met throughout the organization.
• Nestlé is conscious of the fact that the success of a corporation is a reflection of the
professionalism, conduct and the responsible attitude of its management and employees.
Therefore recruitment of the right people and ongoing training and development are
crucial.
• Nestlé continues to maintain its commitment to follow and respect all applicable local laws
in each of its markets.
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5. DATA COLLECTION &RESEARCH METHOD
• Peter Atrill & Eddie McLaney (2011) "Management Accounting for Decision
Makers". Published by Prentice Hall
• Kaplan & Anderson (2001) "Time Driven Activity Based Costing - A simpler more
powerful path to profitability", published by Harvard Publications.
About Technique
Activity-based costing (ABC) is an accounting process that
enables Nestle to assign overhead activities costs of the firm to
the specific products and services it produces & delivers.
Compare to the traditional process, ABC assigns the overheads
and indirect costs less arbitrarily and focuses on true
relationship between costs, overhead activities, and related
products (manufactured, produced) / services delivered by
Nestle.

6. IMPLEMENTATION OF ABC ACCOUNTING
METHOD IN NESTLE COSTING PROBLEMS
Nestle markets two types of products in the Food Processing industry. For sake of simplicity let us call
them Consumer/Non-Cyclical Standard product and Consumer/Non-Cyclical Custom Product. Standard
Product is lot simpler than Custom Product, so Nestle produces Standard product in large batch sizes
compare to Custom product which is produced in smaller batch sizes.
Nestle Standard Product Nestle Custom Product
Annual Sales (Units) 11533 12558
Sales Price (Per Unit) 70 USD 84 USD
Batch Size (units) 1000 50
Direct Labor Time / per unit 2 2.5
Direct Labour rate per hour 8 8
Direct Input cost per unit 22 32
Number of Custom Parts per unit 1 4
Number of Set-Ups per batch 1 3
Separate Material per batch 1 1
Number of Sales Invoices - issued per year 50 240
Overhead Cost Analysis USD Cost Drivers
Set Up Costs 72831 Number of Set Ups
Special part handling cost 60061 Number of Special Parts
Customer invoicing cost 28842 Number of Invoices
Material handling cost 62409 Number of Batches
Other overheads 106540 Labor Hours

7. Solution Based on Traditional Approach of Costing
the answer is no difference at all. ABC is concerned only with the way in which overheads are
charged to job to derive the full cost
How direct costs are treated in ABC? Is it different from the way it is treated under traditional
approach?
• Traditional Approach - Absorption Approach
The difference between the traditional method and ABC can be only noticed when there are different types of
products produced by Nestle and indirect costs comprise a significant chunk of the overall cost structure of
Nestle.
One of the key reasons why small firms still use traditional method is its sheer simplicity. ABC can be highly
complex if the firm is present in number of industries and, produce & market various products around firm's
core competency

8. Step 1 - Calculating Overhead Recovery Rate of Indirect Costs
Overhead Cost Analysis USD
Set Up Costs 72831
Special part handling cost 60061
Customer invoicing cost 28842
Material handling cost 62409
Other overheads 106540
Total Overheads (1+2+3+4+5) 330683
To calculate the "Overhead Recovery Rate" add up all the indirect costs that Nestle is
incurring for both the standard and custom product.
• Overhead Recovery Rate Formula
Overhead Recovery Rate = Total Overheads / Number
of Labor Hours
Overhead Recovery Rate = 6.07 per Hour

9. Step 2 - Product / Service Costs - Adding Direct and Indirect Costs
Standard Product Custom Product
Direct Costs
Labor
Hrs * Labor/hr
16 20
Material 22 32
Indirect Costs
Overheads (recovery rate * hours) 12.14 15.175
Total Costs Per Unit (1+2+3) 50.14 67.175
Using the Overhead Recovery Rate Calculation we can assign the indirect cost to individual
products. We are just allocating the variable or indirect costs based on the hours taken by
labour to produce the standard and custom products.
Total cost per unit under the traditional method can be calculated by adding up - Raw material
costs, labour costs, and indirect cost allocation using Overhead Recovery Rate formula.
The Total Cost per unit of Standard product is 50.14
The Total Cost per unit of Custom product is 67.175

10. Return on Sales Calculations for Nestle
Standard Product Custom Product
USD per Unit USD per Unit
Selling Price 70 84
Total Cost 50.14 67.175
Profit 19.86 16.825
Return on Sales 28.37 20.03
Return on Sales metrics enables the firm to allocate resources where it can
maximize returns. After subtracting the cost per unit of the product from sales
price of the product we can arrive at the profit per unit.
The profit per unit of standard product is higher than custom product. In isolation these
numbers don't provide a great insight as price is often the function of competitive
forces in the market place. To explore further we should analyse - Return on Sales per
unit.

11. Activity Based Costing System for Nestle
• Activity Based Costing can improve the costing process at Nestle in three
prominent ways –
By increasing the number of cost pools – ABC help in identifying the
activities that are being performed by organization’s resources. Often too
narrow allocation can result in unclear understanding of both activities and
how resources spent on them.
•
By assigning costs to various activities that are segmented based on the
role they perform in overall processes. Instead of treating all indirect costs
as one organization wide pool, ABC pools the costs based on each activity.
Finally assigning costs to respective products, service and customers
activities in the organization using activity cost drivers.

12. How to calculate Activity Based Costing & What
is the formula for Activity Based Costing?
• After identifying all the support activities and associated costs & factors
that drive those cost, managers at Nestle can take following steps to
conduct ABC costing -
Step 1- Establishing Cost Pool for each activity based on the Food
Processing dynamics.
Step 2 - Allocating total cost associated with each activity to the relevant
pool.
• Step 3- calculating per Unit Cost based on the relevant cost driver.
Step 4 Final Step - Dividing the amount in each pool by estimated total
usage of the cost driver. Then the unit cost is multiplied by the number of
units of the cost driver of that specific product.

13. You can easily follow the above four steps in the
following table of ABC Calculations.
Overhead
Cost Driver
(a)
Standard
Diver
Volume
(b)
Custom
Diver
Volume
(c) Total
Diver
Volume
a+b
(d)
Costs
USD
(e) Driver
Rate (d/c)
(f) Standard Total
Cost a*e
(g) Custom Total
Cost b*e
Standard Unit
Costs
Custom Unit
Costs
Set Up CostsSet-up
per
Batch
12 720 732 72831 99.49590163
9344
1193.9508196721 71637.049180328 0.10352473941491 5.7044950772677
Special part
handling
cost
Special
Parts
per unit
11533 50232 61765 60061 0.972411559
94495
11214.822520845 48846.177479155 0.97241155994495 3.8896462397798
Customer
invoicing
cost
Invoices
per year
50 240 290 28842 99.45517241
3793
4972.7586206897 23869.24137931 0.431176504005 1.9007199696855
Material
handling
cost
Number
of
Batches
11.533 251.16 262.693 62409 237.5738980
4829
2739.939766191 59669.060233809 0.23757389804829 4.7514779609658
Other
overheads
Labor
Hours
23066 31395 54461 106540 1.956262279
4293
45123.145737317 61416.854262683 3.9125245588586 4.8906556985733

14. ABC Calculations
Per Unit Overhead Cost using ABC
Overhead Unit Cost Standard Custom
Set Up Costs 0.10352473941491 5.7044950772677
Special part handling cost 0.97241155994495 3.8896462397798
Customer invoicing cost 0.43 1.9
Material handling cost 0.23757389804829 4.7514779609658
Other overheads 3.9125245588586 4.8906556985733
Total Overheads 5.66 21.14
There are two steps to calculate per unit overhead costs using ABC method. First
calculate per unit cost based on cost driver usage by specific product and then add
those overhead costs for the product to arrive at Per Unit Overhead Cost of a
product
The total overheads of standard unit using ABC costing is 5.66 and the
overheads of custom unit uning ABC costing method is 21.14

15. Total Cost Using ABC Technique
Standard Product Custom Product
Direct Costs
Labor
Hours * Cost of Labor per Hours
16 20
Material 22 32
Indirect Costs
ABC- Overhead 5.66 21.14
Total Costs Per Unit
(1+2+3)
43.66 73.14
The total cost per unit of standard and custom product
can be calculated by adding up - direct cost, raw material
cost, and ABC derived per unit indirect cost.
The Total Cost per unit of Standard product is 43.66
The Total Cost per unit of Custom product is 73.14
If we compare the total costs using traditional method and ABC method, we can easily
observe that the difference between the total cost of custom product to that of standard
product is far higher under ABC method than it is under the tradtional method.

16. Return on Sales Using ABC Costing Analysis
Standard Product Custom Product
USD per Unit USD per Unit
Selling Price 70 84
Total Cost 43.66 73.14
Profit 26.34 10.86
Return on Sales 37.63 12.932
The profit per unit of standard product is higher than custom product under ABC
technique. By comparing the Return on Sales numbers under both traditional and ABC
technique - We can easily conclude that ABC is far more effective costing technique for
Nestle as it stops inefficient allocation of costs to Standard product. Nestle should focus
on standard product rather than custom product as standard product is delivering much
higher returns on sales.

17. Limitations of ABC Costing Method
• ABC is time consuming and costly.
• Setup costs and updating cost for example in the automobile
industry is very high and ABC fails to inculcate it.
• Business with similar product and services output that require
similar activities then the benefits from ABC are very limited.

18. THANK YOU.