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Ashirdeep Singh
Harsh Kumar
Rahul mattoo
Conventional Costing
Total Cost = Material + Labour+ Overheads
Overheads are allocated to the products on volume
based measures e.g. labour hours, machine hours,
units produced
Will this not distort the costing in the new
environment?
Conventional Costing
Expenses
AB Costing
Economic
Element
Resources
Activities
Work
Performed
Cost Objects
Product or
service
Cost Objects
Basics of A B C
Cost of a product is the sum of the costs of
all activities required to manufacture and
deliver the product.
Products do not consume costs directly
Money is spent on activities
Activities are consumed by
product/services
Basics of A B C (contd.)
ABC assigns Costs to Products by tracing
expenses to activities. Each Product is charged
based on the extent to which it used an activity
TERMINOLOGIES.
Cost
cost.
A factor such as level of activity or volume
that casually affects cost.
Existence of a cause-and-effect relationship
between a change in the level of activity or
volume and change in the level of total
costs of that cost object.
Thus cost drivers signify factors, forces or
events that determine the costs of activities
Ram And
Harshit over
costed.
Saquib
under costed
NUMERICAL..
Production:
CL 20000
NL 80000
Manufacturing labor hours = 50000
DIRECT COST
NL
Direct Material = 1520000
Direct labor
= 800000
Total direct cost = 2320000
Direct cost per unit = 2320000/80000 = 29
CL
Direct Material = 920000
Direct labor
= 260000
Total direct cost = 1180000
Direct cost per unit = 1180000/20000 = 59
Conventional method
Cost/labor hour
Cost 2900000/50000
=Rs.58
Super uses 36000 manufacturing
labor-hours to male NL and 14000
direct manufacturing labor-hours to
make CL
CL 14000*58= 812000
NL 36000*58= 2088000
TOTAL COST.
Normal lenses
Direct cost
Rs.2320000+Allocated
2088000
= 4408000
Complex lenses
Direct cost
Rs.1180000 + Allocated
812000 = 1992000
COST HIERARCHY
Activity/Cost
Plant depreciation
Building rent
Management of facility
Product/customer-level
Batch-level
Machine setups
Processing purchase orders
Batch quality inspections
Unit-level
Nonmanufacturing
costs
Traditional
product costing
ABC
product costing
Traditional
product costing
Nonmanufacturing
costs
Mo
st,
not but
all
Some
All
Manufacturing
costs
ABC
product costing
Level of complexity
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
ActivityBased
ActivityBased
Costing
Costing
Departmental
Departmental
Overhead
Overhead
Rates
Rates
Plantwide
Plantwide
Overhead
Overhead
Rate
Rate
Each
Each ABC
ABC cost
cost pool
pool has
has its
its
own
own unique
unique measure
measure of
of activity.
activity.
Traditional
Traditional cost
cost systems
systems usually
usually rely
rely
on
on volume
volume measures
measures such
such as
as direct
direct labor
labor
hours
hours and/or
and/or machine
machine hours
hours to
to allocate
allocate
all
all overhead
overhead costs
costs to
to products.
products.
ABC uses more cost pools.
Activity
Activity
Cost Pool
$$
$
$ $
$
Activity
Activity
Measure
An
An allocation
allocation base
base
in
in an
an activity-based
activity-based
costing
costing system.
system.
The
The term
term cost driver
driver
is also used
used to
to refer
refer
to an
an activity
activity
measure.
measure.
Duration
driver
Simple count
of the number of
times an activity
occurs.
A measure
of the amount
of time needed
for an activity.
ABC defines
five levels of activity
that largely do not relate
to the volume of units
produced.
Traditional
Traditional cost
cost systems
systems usually
usually rely
rely on
on volume
volume
measures
measures such
such as
as direct
direct labor
labor hours
hours and/or
and/or machine
machine
hours
hours to
to allocate
allocate all
all overhead
overhead costs
costs to
to products.
products.
MERITS OF ABC
Brings accuracy and reliability in product cost
determination by focusing on cause and effect relationship
in the cost incurrence.
Recognizes that activities creates costs , not products
It is product which consumes activities.
ABC provides more realistic product costs in advanced
service or support driven environment
Behavior of many fixed overhead costs in relation to
activities now become more visible and clear.
Helps in reducing costs and identifying activities which
do not add value
Uses multiple cost drivers which are transaction based
rather than volume based
MERITS OF ABC
ABC traces costs to areas of managerial
responsibility, process, customers, department
besides the product costs.
It improves greatly the managers decision
making .
Produce reliable and correct cost data in case of
diversity
Very useful for cost management.
Cost driver rates can be used for design of new /
exixting products as hey indicate overhead costs
that are likely to be applied in costing of the
product.
DEMERITS OF ABC
Complex system
Requires lot of records and tedious calculation
Not suited for small organizations
Sometimes it is difficult to attribute costs to
single activities as some costs support several
activities.
Difficult in implementation
Different level of utility for different firms.
Costly to manage
Only successful if there is total support from top
management.
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 1
Step 2
NL
CL
Direct material
Direct labor
Mold cleaning and
maintenance
IMPLEMENTING
ACTIVITY-BASED COSTING
Cleaning and maintenance costs of
360,000 are direct batch-level costs.
Why?
Because these costs consist of workers
wages for cleaning molds after each
batch of lenses is run.
IMPLEMENTING
ACTIVITY-BASED COSTING
Normal Lenses (NL)
Cost Hierarchy
Description
Category
Direct materials
Unit-level
Direct mfg. labor
Unit-level
Cleaning and maint. Batch-level
Total direct costs
1,520,000
800,000
160,000
2,480,000
IMPLEMENTING
ACTIVITY-BASED COSTING
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 3
Select the cost-allocation bases to use for
allocating indirect costs to the products.
(1)
Activity
Design
Setups
Operations
(2)
Cost Hierarchy
Product-sustaining
Batch-level
Unit-level
(3)
Total Costs
450,000
409,200
637,500
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 4
Identify the indirect costs associated
with each cost-allocation base.
Overhead costs incurred are assigned
to activities, to the extent possible, on
the basis of a cause-and-effect relationship.
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 5
Compute the rate per unit.
Setup-hours:
(1)
NL
640
CL
2,000
(5)
Total
2,640
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 6
Compute the indirect costs allocated
to the products.
NL: 155 640 =
CL: 155 2,000 =
Total
99,200
310,000
409,200
IMPLEMENTING
ACTIVITY-BASED COSTING
Step 7
Compute the costs of the products.
NL and CL would show three
direct cost categories.
1.
Direct materials
2.
3.
IMPLEMENTING
ACTIVITY-BASED COSTING
NL and CL would show six indirect cost pools.
1.
Design
2.
3.
Manufacturing operations
4.
Shipment setup
5.
Distribution
6.
Administration
ACTIVITY-BASED MANAGEMENT
Activity-based management (ABM)is a method of
identifying and evaluating activities that a
business performs usingactivity-based costingto
carry out avalue chainanalysis or a reengineering initiative to improve strategic and
operational decisions in an organization.
Activity-based costingestablishes relationships
betweenoverhead costsand activities so that
overhead costs can be more precisely allocated to
products, services, or customer segments.
Activity-based management focuses on managing
activities to reduce costs and improve customer
value.
TYPES OF ABM
Operational ABMis about doing things right,
using ABC information to improve efficiency.
Those activities which add value to the product
can be identified and improved. Activities that
dont add value are the ones that need to be
reduced to cut costs without reducing product
value.
Strategic ABMis about doing the right things,
using ABC information to decide which products
to develop and which activities to use. This can
also be used for customer profitability analysis,
identifying which customers are the most
profitable and focusing on them more.
EVALUATION OF ABM
The benefits of ABM (and ABC) are greatest in
organisations that have high indirect costs.
Users of ABM and ABC often assume that all
overhead costs are variable. This is not the case,
and some overhead costs will be fixed, so will not
be saved if activities are reduced.
ABM is also complex and is expensive to
implement. For small businesses, or businesses
with narrow product ranges, the benefits of
implementing ABM may not justify the costs.
RISK ANALYSIS
A risk with ABM is that some activities have an
implicit value, not necessarily reflected in a
financial value added to any product.
For instance a particularly pleasant workplace
can help attract and retain the best staff, but
may not be identified as adding value in
operational ABM.
A customer that represents a loss based on
committed activities, but that opens up leads in a
new market, may be identified as a low value
customer by a strategic ABM process.