A b c

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A b c

  1. 1. CA.Chandra Sekhar Veeraghanta A B C Activity Based Costing
  2. 2. ABC Concepts <ul><li>What is ABC ? </li></ul><ul><ul><li>Inventory Valuation method ? </li></ul></ul><ul><ul><ul><li>Yes, if it replaces traditional full absorption/ variable costing method </li></ul></ul></ul><ul><ul><li>Resource Consumption Decision Support Model ? </li></ul></ul><ul><ul><ul><li>Yes, provides info about how & why resources are consumed </li></ul></ul></ul><ul><ul><li>Cost Accumulation Method ? </li></ul></ul><ul><ul><ul><li>Does not replace job order costing & process costing but, enhances the accuracy of product costs </li></ul></ul></ul>
  3. 3. Problems with Traditional Systems <ul><li>Product Cost Distortions </li></ul><ul><ul><li>O/H allocation based on production volume while the consumption of resources is not in proportion to volume of products produced. </li></ul></ul><ul><li>Excluding Non-Manufacturing Costs </li></ul><ul><ul><li>Product related Design, Admin, Selling & Distribution, Customer Service costs are not traced to inventory </li></ul></ul>
  4. 4. Causes for Product Cost Distortions <ul><li>Product Volume Diversity </li></ul><ul><ul><li>Low Volume product receives low O/H </li></ul></ul><ul><ul><li>High Volume product receives high O/H </li></ul></ul><ul><ul><li>Both products require Engg., Purchase, etc support irrespective of number of units produced. </li></ul></ul><ul><li>Product Diversity </li></ul><ul><ul><li>Small products require less production volume related inputs – such as direct labour; but, may not necessarily mean less on support. </li></ul></ul><ul><ul><li>Small product – design complexity, longer setup hrs etc </li></ul></ul>
  5. 5. SUMMARY OF COST DISTORTIONS THAT TEND TO OCCUR IN TRADITIONAL COST SYSTEMS Overcost Requires few, short or simple machine setups. Undercost Requires many, long or complex machine setups. Product Machine setup requirements Overcost Requires few, or common parts, i.e., same part used on many products. Undercost   Requires many, or unique parts, i.e., only used on a single product. Product Materials requirements Overcost Simple design Undercost Complex design Product Complexity Overcost Large Undercost Small Product Size Overcost, i.e., too much overhead is allocated to these products. High Volume main line Undercost, i.e., too little overhead is allocated to these products. Low Volume specialty Production volume TYPE OF COST DISTORTION  THAT TENDS TO OCCUR IN  TRADITIONAL COST SYSTEMS PRODUCT TYPE OR CHARACTERISTIC TYPE OF DIVERSITY
  6. 6. The Logic of ABC <ul><li>Designing, Producing & Distribution of Products/ service requires – activities to be performed. </li></ul><ul><li>Performing these activities requires resources – to be purchased & used </li></ul><ul><li>Using Resources - costs </li></ul>
  7. 7. The Logic of ABC <ul><li>Restate in reverse order : </li></ul><ul><ul><li>Resources generate costs </li></ul></ul><ul><ul><li>Activities consume resources </li></ul></ul><ul><ul><li>Products consume activities </li></ul></ul>
  8. 8. The Logic of ABC
  9. 9. The Logic of ABC <ul><li>Company’s activities are identified </li></ul><ul><li>  Costs are traced to these activities ( or activity cost pools ) based on the resources they require </li></ul><ul><li>  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. </li></ul>
  10. 10. ACTIVITY VOLUME – ACTIVITY MEASURES <ul><li>Activity Volume refers to an input or output measurement of the quantity of the work performed to accomplish an activity. </li></ul><ul><li>These measurements may represent the frequency, duration, or physical volume of an activity </li></ul><ul><li>ABC uses both production volume and non-production volume activity measures to trace costs </li></ul>
  11. 11. EXAMPLES OF ACTIVITY COST POOLS AND ACTIVITY MEASURES Product or batch level. Number of inspections or inspections time. Inspection and quality control Product or batch level. Number of part numbers or administrative hours. Inventory control and materials planning Product or batch level. Number of times handled or material handling hours. Materials handling Batch level. Number of setups or setup time. Machine Setup Product or batch level. Number of pounds shipped. Shipping Product or batch level. Number of shipments, number of cubic feet or packing hours. Packing Product level. Number of engineering work orders or hours. Engineering Product or batch level. Number of purchase orders or shipments received. Receiving and Storing Product or batch level. Number of purchase orders or ordering hours. Purchasing Unit level. Number of machine hours. Machining parts PROBABLE COST CLASSIFICATION* POTENTIALLY USEFUL ACTIVITY MEASURES ACTIVITY COST POOL
  12. 12. ABC COST HIERARCHY <ul><li>A cost classification scheme which places all costs into one of the following categories : </li></ul><ul><ul><li>Unit level – the cost of an activity required once each time a unit of product is produced. </li></ul></ul><ul><ul><li>Batch level – the cost of an activity required each time a batch of products is produced. </li></ul></ul><ul><ul><li>Product level – the cost of an activity required to support a specific type of product. </li></ul></ul><ul><ul><li>… </li></ul></ul>
  13. 13. ABC COST HIERARCHY <ul><li>A cost classification scheme which places all costs into one of the following categories : </li></ul><ul><ul><li>… </li></ul></ul><ul><ul><li>Facility Level – the cost of an activity associated with maintaining the facility or plant </li></ul></ul><ul><ul><li>Customer level – the cost of an activity required to support a specific customer </li></ul></ul>
  14. 14. Activities – Drivers - Measures <ul><li>Activities : Types of work performed – purchasing, designing etc </li></ul><ul><li>Cost and Activity Drivers : Underlying cause for the cost </li></ul><ul><li>Activity Measure : A unit of measurement chosen to represent the activity volume </li></ul>
  15. 15. ABC CONCEPTS AND TERMINOLOGY Dialing a vendor's phone number. Part of a task. Sub tasks Calling vendors. A minor type of work that supports a sub activity. Tasks Preparing purchased orders. A lower level type of work, or activity that supports a main activity. Sub activities Purchasing raw materials. A major type of work, function or high level activity. Main activities Examples Definition Type Activities - A type of work or function.
  16. 16. ABC CONCEPTS AND TERMINOLOGY Purchasing raw materials, preparing purchase orders. A resource consuming activity that is caused by a previous activity or event. Secondary drivers Company's overall objectives, customer demands and product specifications. The initial cause of an activity that requires resources, i.e., whatever creates the demand for an activity. Primary drivers Examples Definition Type Drivers - Whatever causes the need for activities to be performed.
  17. 17. ABC CONCEPTS AND TERMINOLOGY Cubic feet packed, pounds shipped. The quantity of a resource processed by an activity. Physical measures Ordering hours, engineering hours, machine hours. The time consumed performing the activity. Duration measures Number of purchase orders, number of engineering work orders. The number of times an activity is performed. Frequency measures Examples Definition Type Activity measures - A unit of measure chosen to represent an activity volume.
  18. 18. ABC TECHNIQUE <ul><li>FOUR STEPS IN DESIGNING AN ABC SYSTEM OR SUB-SYSTEM </li></ul><ul><ul><li>1) identifying a company's main activities, </li></ul></ul><ul><ul><li>2) determining the primary and secondary drivers for these activities, </li></ul></ul><ul><ul><li>3) aggregating activities into homogenous cost pools and </li></ul></ul><ul><ul><li>4) selecting activity measures to represent each pool. </li></ul></ul>
  19. 19. THREE STEPS TO OBTAIN ABC COSTS <ul><li>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: </li></ul><ul><li>    Rj = Annual costs of activity j ÷ Annual quantity of activity j </li></ul><ul><li>where: Rj = the activity overhead rate for activity j.       j = the number of the activity. </li></ul>
  20. 20. THREE STEPS TO OBTAIN ABC COSTS <ul><li>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, </li></ul><ul><li>    Ci = Di + Σ (Rj)(Aji) </li></ul><ul><li>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 &quot;the sum of&quot;. </li></ul>
  21. 21. THREE STEPS TO OBTAIN ABC COSTS <ul><li>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. </li></ul><ul><li>    </li></ul><ul><li>ABC unit cost for product i = Ci ÷ Units of product i. </li></ul>
  22. 22. EXAMPLE ANNUAL PRODUCT DATA FOR COMPANY A ANNUAL ACTIVITY COSTS FOR COMPANY A 1,000  Rs.50 1 Rs.10 2 8 4 100  Rs.50 1 Rs.10 1 4 2 Annual production quantity in units Material cost per unit Direct labour hours per unit Direct labour cost per hour Number of purchase orders required per year Number of engineering work orders required per year Number of machine setups required per year V2 V1 PRODUCT RELATED DATA   Number of purchase orders   Number of engineering work orders   Number of machine setups   Number of direct labour hours   Number of materials rupees Rs.24,000 18,000 24,600 22,000 11,000 Rs.99,600 ====== Purchasing and receiving Engineering Machine setup Machining, power & maintenance Materials planning & handling Total factory overhead costs ACTIVITY MEASURE ANNUAL COSTS ACTIVITY
  23. 23. EXAMPLE <ul><li>ARE THERE ANY HOMOGENEOUS COST POOLS ? </li></ul><ul><ul><li>one for non-production volume related costs and one for production volume related costs </li></ul></ul><ul><ul><li>consumption proportions for the three non-production related costs pools (purchasing/receiving, engineering and setups) are the same and </li></ul></ul><ul><ul><li>consumption proportions for the two production related cost pools (machining/power/maintenance, and materials planning/ handling) are the same </li></ul></ul><ul><ul><li>Combine the cost pools into a single homogeneous cost pool and trace to products </li></ul></ul>
  24. 24. EXAMPLE ANNUAL ACTIVITY COSTS FOR COMPANY A COMBINED HOMOGENEOUS COST POOLS   Number of purchase orders  Number of direct labour hours   Rs.66,600 33,000 Rs.99,600 Non-production volume related Production volume related Total factory overhead costs ACTIVITY MEASURE ANNUAL COSTS ACTIVITY POOL
  25. 25. <ul><li>Calculating ABC Costs for Company A </li></ul><ul><li>Step 1: Calculating Activity Overhead Rates Rj = Annual costs of activity j ÷ Annual quantity of activity j </li></ul><ul><ul><li>1. Non-production volume related = Rs.66,600 ÷ 3* = Rs.22,200 per purchase order. </li></ul></ul><ul><ul><li>* Total purchase orders = 1 for V1 and 2 for V2. </li></ul></ul><ul><ul><li>2. Production volume related = Rs.33,000 ÷ 1,100* = Rs.30 per direct labour hour. </li></ul></ul><ul><ul><li>* Total direct labour hours = 100 for V1 and 1,000 for V2. </li></ul></ul>EXAMPLE
  26. 26. EXAMPLE COMPANY A COSTS TRACED TO PRODUCTS V1 AND V2 USING AN ACTIVITY BASED COST (ABC) SYSTEM Rs.134.40 ====== Rs.134,400 ======= Rs.312.00 ====== Rs.31,200 =======   Totals 10.00 10,000 10.00 1,000 (Rs.10)(1hr)(100) (Rs.10)(1hr)(1,000) 4. Direct Labour: 50.00 50,000 50.00 5,000 (Rs.50)(100) (Rs.50)(1,000) 3. Direct Material: Rs.74.40 Rs.74,400 Rs.252.00 Rs.25,200   Total Overhead 30.00 30,000 Rs.30.00 3,000 (Rs.30)(100 DLH) (Rs.30)(1,000 DLH) 2. Production volume related: Rs.44.40 Rs.44,400 Rs.222.00 Rs.22,200 (Rs.22,200)(1 PO) (Rs.22,200)(2 PO'S) 1. Non-production volume related: ABC UNIT COST V2**   C2=COST TRACED TO V2 ABC UNIT COST V1*   C1=COST TRACED TO V1 ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE (Rj)(Aji)   COST POOL OR CATEGORY
  27. 27. EXAMPLE COMPANY A COST TRACED TO PRODUCTS V1 AND V2 USING A TRADITIONAL PRODUCTION VOLUME BASED (PVB) COST SYSTEM Rs.150.55 ====== Rs.150,545.45 ======== Rs.150.55 ====== Rs.15,054.55 ========   Totals 10.00 10,000 10.00 1,000.00 (Rs.10)(1hr)(100 units) (Rs.10)(1hr)(1,000) 4. Direct Labour: 50.00 50,000 50.00 5,000.00 (Rs.50)(100 units) (Rs.50)(1,000) 3. Direct Material: Rs.90.55 Rs.90,545.45 Rs.90.55 Rs.9,054.55   Total Overhead 30.00 30,000.00 Rs.30.00 3,000.00 (Rs.30)(100 DLH) (Rs.30)(1,000) 2. Production volume related: Rs.60.55 Rs.60,545.45 Rs.60.55 Rs.6,054.55 (Rs.60.5455)(100DLH) (Rs.60.5455)(1,000) 1.Non-production volume related: PVB UNIT COST V2** COST ALLOCATED TO V2 PVB UNIT COST V1* COST ALLOCATED TO V1 ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE   COST POOL OR CATEGORY
  28. 28. EXAMPLE
  29. 29. EXAMPLE 2 ANNUAL PRODUCT DATA FOR COMPANY B 1,000 Rs.500 10 Rs.10 2 8 4 1,000 Rs.50 1 Rs.10 2 8 4 Annual production quantity in units Material cost per unit Direct labour hours per unit Direct labour cost per hour Number of purchase orders required Number of engineering work orders required Number of machine setups required V3 V2 PRODUCT RELATED DATA
  30. 30. EXAMPLE 2 ANNUAL ACTIVITY COSTS FOR COMPANY B SEPARATE AND COMBINED HOMOGENEOUS COST POOLS   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 Rs.32,000  24,000 32,800 Rs.88,800 220,000 110,000 330,000 Rs.418,800 ======= Purchasing and receiving Engineering Machine setup Non-production volume related Machining, power & maintenance Materials planning & handling Production volume related Total factory overhead costs ACTIVITY MEASURE ANNUAL COSTS ACTIVITY
  31. 31. <ul><li>Calculating ABC Costs for Company B </li></ul><ul><li>Step 1: Calculating Activity Overhead Rates Rj = Annual costs of activity j ÷ Annual quantity of activity j </li></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>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. </li></ul></ul>EXAMPLE 2
  32. 32. EXAMPLE 2 COMPANY B COST TRACED TO PRODUCTS V2 AND V3 USING AN ACTIVITY BASED COST (ABC) SYSTEM Rs.944.40 ====== Rs.944,400 ======= Rs.134.40 ====== Rs.134,400 =======   Totals 100.00 100,000 10.00 10,000 (Rs.10)(1hr)(1,000) (Rs.10)(10hrS)(1,000) 4. Direct Labour: 500.00 500,000 50.00 50,000 (Rs.50)(1,000 units) (Rs.500)(1,000 units) 3. Direct Material: Rs.344.40 Rs.344,400 Rs.74.40 Rs.74,400   Total Overhead 300.00 300,000 Rs.30.00 30,000 (Rs.30)(1,000 DLH) (Rs.30)(10,000 DLH) 2. Production volume related: Rs.44.40 Rs.44,400 Rs.44.40 Rs.44,400 (Rs.22,200)(2 PO'S) (Rs.22,200)(2 PO'S) 1. Non-production volume related: ABC UNIT COST V3** C3=COST TRACED TO V3 ABC UNIT COST V2* C2=COST TRACED TO V2 ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE (Rj)(Aji)   COST POOL OR CATEGORY
  33. 33. EXAMPLE 2 COMPANY B COST TRACED TO PRODUCTS V2 AND V3 USING A TRADITIONAL PRODUCTION VOLUME BASED (PVB) COST SYSTEM Rs.980.73 ====== Rs.980,727 ======== Rs.98.07 ====== Rs.98,072.70 ========   Totals 100.00 100,000 10.00 10,000.00 (Rs.10)(1hr)(1,000) (Rs.10)(10hrs)(1,000) 4. Direct Labour: 500.00 500,000 50.00 50,000.00 (Rs.50)(1,000 units) (Rs.500)(1,000 units) 3. Direct Material: Rs.380.73 Rs.380,727.00 Rs.38.07 Rs.38,072.70   Total Overhead 300.00 300,000.00 Rs.30.00 30,000.00 (Rs.30)(1,000 DLH) (Rs.30)(10,000) 2. Production volume related: Rs.80.73 Rs.80,727.00 Rs.8.07 Rs.8,072.70 (Rs.8.0727)(1,000) (Rs.8.0727)(10,000) 1.Non-production volume related: PVB UNIT COST V3** COST ALLOCATED TO V3 PVB UNIT COST V2* COST ALLOCATED TO V2 ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE COST POOL OR CATEGORY
  34. 34. <ul><li>Thank you </li></ul>

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