Lecture 4 - ABC - Illustrations PDF

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Summary

Emmanuel Namawa
MBA, CPA, BCOM...

Description

Activity Based Costing Formula Activity Based Costing Formula = Cost Pool in Total / Cost Driver The ABC formula can be explained with the following core concepts. 

Cost Pool: This is an item for which measurement of the cost would require e.g. a product



Cost Driver: It is a factor that will cause a change in the cost of that activity. There are 2 kinds of cost driver: o 1) Resource Cost Driver: It is a measure of the quantity of resources which shall be consumed by an activity. This will be used to assign the cost of a resource to an activity. E.g. Electricity, Staff wages, Advertising, etc. o 2) Activity Cost Driver: This is the measure of the intensity of demand and the frequency that is placed on the activities by the cost pools. It will be used to assign the activity costs to a product or a customer. E.g. Material ordering costs, Machine set up costs, Inspection and testing charges, Material handling and storing costs, etc.

Example 1 BAC ltd is considering shifting from traditional costing method to ABC based costing method and it has got the following details. Using ABC costing formula, find out the new overhead rates for the company. Below is given data for calculation of Activity Based Costing; Activity Machine Set up Inspection

Budgeted Cost 200,000 140,000

Cost Driver Number of machine setups Inspection hours

Cost 340 7,500

Ans. Solution: We are here given two activities, first one is machine set-up activity and the second one is inspecting the same, so the drivers are as the number of machine setup would increase the cost would also increase and similarly as the number of inspecting hours increases that would lead to increase in inspection cost as well. Hence, we need to allocate those cost based upon their cost drivers. Using the ABC formula: Cost Pool total / Cost driver

Example 2

Following details pertains to different activities and their costs for Gamma Ltd. You are required to calculate the overhead rate for each activity. Below is given data for calculation of Activity Based Costing. Activity Cost Pool

Estimate

Cost Driver

Expected Activity Standar Specialt Total

d d Purchasing Production steps Inspection Assembling Machine

Overhead 120,000 202,500 160,000 80,000 300,000

Number of purchase orders Number of set ups Inspection hours Assembly hours Machine hours

y 82 50 300 800 5,000

118 200 500 800 5,000

200 250 800 1,600 10,000

maintenance

Ans. Solution

Example 3 Mamata Inc. a manufacturing company of drugs is considering switching from their traditional method of cost to a newly implemented system by their production head which is activity-based

costing so that the two-products Z serum and W serum can be sold at their proper cost and make them price competitive in the market. Below are the production details that have been derived from the production sheet. Activity Cost Pool

Estimated

Purchasing Material Handling Production steps Inspection Assembling Machine Maintenance

Overhead 60,000 75,000 101,250 80,000 40,000 150,000

Cost Driver

Expected Activity Z serum W serum

Number of purchase Orders Number of Purchase Receipts Number of setups Inspection Hours Assembly Hours Machine Hours

410 580 250 1,500 4,000 20,000

590 920 1,000 2,500 4,000 20,000

Ans. Solution You are required to arrive at product based total cost using ABC formula. We are here given six activities hence; we need to allocate those cost based upon their cost drivers. Using the ABC formula: Cost Pool total / Cost driver Each activity pool total cost is divided by its cost driver to arrive at different rates. Determine the Overhead rate for every activity? Determine the Product level total cost ?

Total 1,000 1,500 1,250 4,000 8,000 40,000...