Question

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Q1 Give example of company using ABC costing and explain the process used in this company to assign costs in an ABC system? (Week 7: , ABC costing)

Answer:

      Q 2 Give examples of questions managers could ask to help them identify relevant qualitative factors that will be used before making decision? (Week 9: ,   Relevant information for decision making)

Answer:

      Q 3 Kadhim Co. manufactures product B which is a part of its main product. Kadhim Co makes 50,000 units of product B per year. The production costs are detailed below. An outside supplier has offered to supply 50,000 units of product B per year at $ 2.45 each. Fixed production cost of $ 40,000 associated with the product B are unavoidable. Should Kadhim Co make or buy the product B?

The production cost per unit for manufacturing a unit of product B are:

Direct Materials	0.85
Direct Labor	0.65
Variable Manufacturing Overhead	0.40

   (Week 9: Relevant information for decision making)

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Answer 1

Meaning and Definition of Activity Based Costing

Activity Based costing is an accounting methodology that assigns cost to activities rather than products or services. This enables resources and overhead costs to be more accurately assigned to products and services that consume them. ABC is a technique which involves identification of costs with each cost driving activity and making it as the basis for apportionment of costs over different cost objects/jobs/products/customers and services.
CIMA defimes Activity Based Costing as an approach to the costing and monitoring of activities which involve tracing resource assumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates. The latter utilises cost drivers to attach activity costs to outputs.

Let us take a small example to understand how this system works in a company

Assume that a company makes widgets and the management decides to install an ABC System.The management decides that all overhead costs will have only three cost drivers viz. Direct labour hours, machine hours and number of purchase orders and the general ledger of the company shows the following overhead costs.

General ledger	Amount in Rs
Payroll taxes	1000
Machine maintenance	500
Purchasing dept labour	4000
Fringe benefits	2000
Purchasing dept supplies	250
Equipment Depreciation	750
Electricity	1250
Unemployment insurance	1500
TotaL	11250

So which overheads do you think are driven by direct labour hours?
The answer is

Payroll taxes	1000
Fringe benefits	2000
Unemployment insurance	1500
TOTAL	4500

Similarly overheads driven by machine hours include Machine maintenance, depriciation and electricity totaling Rs 2500 and finally overheads driven by number of purchase orders include purchasing dept labour and purchasing department supplies totatling Rs 4250.
Now overhead rate is calculated by the formula total cost in the activity pool/base, BAse being the total number of labour hours , machine hours , and total number of purchase orders in the given case.

Assume that total number of labour hours be 1000 hours , machine hours be 250 hours and total purchase orders be 100 orders.

So cost driver rate would be

Cost driver rate	Rs
Rs 4500/1000	Rs 4.50 per labour hour
Rs 2500/250	Rs 10 per machine hour
Rs 4250/100	Rs 42.50 per purchase order

Now lets allocate the overheads between twoo widgets A and B the details of which are given below

Particulars	Widget A	Widget B
Labour hours	400	600
Machine hours	100	150
Purchase orders	50	50

So total overheads cost applied to widget A = (400*4.50) + (100*10) + (50*42.50) = Rs 4925
And total overheads applied to widget B = (600*4.5) + (150*10) +(50*42.5) =6325

So total overheads = Rs 4925+6325 =Rs 11250

Generally in the traditional costing method, overheads are applied on the basis of direct labour hours ( total 1000 labour hours in the given case) So, in that case the overhead absorption rate would be =11250/1000 = Rs 11.25 per hour and the total overheads applied to widget A would have been = 400*11.25 = 4500 and to widget B = 600*11.25 = 6750.

Hence Widget A would have been undervalued and widget B overvalued by rs 425.

The different stages involved in ABC calculations are as follows:-

1. Identify the different activities within the organisation.
2. Relate the overheads to the activities.
3. Support activities are then spread across the primary activities.
4. Determine the activity cost drivers.
5. Calculate activity cost driver rates for each activity
   Activity cost driver rate = Total cost of activity / Activity driver