Development of ABC System

7/30/2019 Development of ABC System

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Presented by-Sneha Bajpai

MBA-2nd sem

Roll no.-39FMS-BHU


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Two-Dimensional ABC and Activity-Based Management

Cost Assignment ViewResource cost

activities

Cost objects

Process ViewActivity AnalysisRootcause

Activitytriggers

ActivityEvaluationPerformance

measures


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Traditional product costing systems weredesigned when the company manufacturednarrow range of products. Also it can onlymeasure volume related cost. Non-volumerelated activities like material handling , set-

up etc are important and their costs cannotbe apportioned on volume basis.

However today companies produce a widerange of products. Simple methods of

apportioning overheads based on directlabour are not justified.

Hence the need for activity based costingarises.


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All of a companys activities are considered as product

costs. Philosophy of ABC is that costs can be controlledmore effectively by focusing directly on managing theforces that cause the activities-the cost drivers ratherthan costs. Thus ABC provides better and more accurateinformation and decision making on prices and product

mix and for the control of manufacturing operations. Costs are grouped into pools according to the

activities which drive them. E.g.-a cost pool may be ofprocurement of goods. In this, all the costs associatedwith the procurement(ordering,inspection,sorting)would

be included in this cost pool and cost driver identified.The procurement cost per requisition is then calculatedand this provides a means of tracing the cost ofprocurement to product.


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The following are the three key areas of ABC: Product cost differentiation

activities and their cost drivers

identification of non-value added costABC is the planned and systematic study and

determination of cost of each of the branchesof business activities that add to the value of

product and services. This matrix shows longand short term cost strategy presented asfollows: Short term Long term

Product value

pricing

Value addition

Corporate growth


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The steps required to develop an ABC system are as

follows- Identify the main activities performed in the

organization, such as manufacturing, assemblyetc., as well as support activities ,includingpurchasing ,packing and dispatching.

Identify the factors which influence the cost of eachactivity-the cost drivers.

Collecting accurate data on direct labour , materialand overhead costs.

Establishing the demands made by particularproducts on activities, using the cost drivers as ameasure of demand.

Trace the cost of activities to products according toa products demand for each activity.


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Focus on expensive resources, thus directingattention to resource categories where the new

costing process has the potential to make bigdifferences on product cost.

Emphasis on resources whose consumption variessignificantly by product and product type-look fordiversity.

Focus on resources whose demand patterns are un-correlated with traditional allocation measures.

ABC is the process of tracing costs first from resourcesto activities and then from activities to specificproducts. The technique of ABC lays the importance

of different costs for different purposes and theidentification of just those costs, which are relevantto a particular decision. It refines the ideas andconcepts of conventional methods.


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Functional areas Activities involved Cost driversMaterial management 1.Issuing tenders

2.Receiving indents3.Inspection ofmaterial

No. of tenders issuedNo. of indentsNo. of purchaseorders

Quality management 1.Receive sample2.Test sample3.Issue of testcertificates

No. of batchesproduced

Personal management 1.Recruitment2.Training3.Labour turnover

No. of employeerecruited

marketing 1.Demand criterion2.Advertising effort3.Preparation of salesforecast

Percentage increasein salesTime spent withdistributors


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A COMP. PRODUCES 4 PRODUCTS A ,B ,C, D USING THE SAME PLANT ANDPROCESS. FOLLOWING ARE THE INFO RELATED TO PRODUCTION PERIOD:

ILLUSTRATION:

product volume MATERIALCOST/UNIT DIRECTLABOUR/UNIT HOURMACHINETIME/UNIT LABOURCOST/UNITRS.

A 500 5 3

B 5000 15 3

C 600 16 2 1 12

D 7000 7 1 1/2 1 1/2 9TOTAL PRODUCTION OVERHEADS:Factory overhead applicable to machine oriented activity : Rs. 37,425Set up cost : Rs. 4,355Cost of ordering material : Rs. 1,920Handling material : Rs. 7,580Administration for spare parts : Rs. 8,600

Rs. 59,880


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PERIOD No. of setups No. ofmaterialordered

No. of timematerialhandled

No. of sparepartsA 1 1 2 2

B 6 4 10 5

C 2 1 3 1

D 8----174----10

12-----274----12

COMPUTEAN OVERHEAD COST PER PRODUCT USING ABC, TRACING

OVERHEADS TO PRODUCTION UNITS BY MEANS OF COST DRIVERS.


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SOLUTION:

Overhead cost based on machine hr rate:

product volume machinetime/unit Total machinetimeA 500 125

B 5000 1250

C 600 1 600

D 7000 1 1/2 10500

--------12475

TOTAL OVERHEAD COST ABSORBED BY THE PRODUCTS= TOTAL PRODUCTIONOVERHEAD/ total machine time

Rs. 59880/12475= Rs. 4.80 per hour

Thus overhead cost per product A= 1/4 of Rs 4.80 = Rs 1.20B= 1/4 of Rs 4.80 =Rs 1.20C= 1 of Rs. 4.80 =Rs. 4.80D=1.5 of Rs. 4.80 = Rs. 7.20


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Factory overhead applicable to machine oriented activity= Rs 37,424

Total machine hours=12,475

Machine hour rate for machine overhead charges= 37,424/12,475= Rs. 3 per hour

Set up cost to be applied on the basis of no of set ups=Rs 4355/17=Rs 256.18 per set-ups

(Cost driver is no. of set-ups)

Materials ordering cost to be absorbed on the basis of number of materialorders= ordering cost/ total no of orders

= Rs 1920/10= Rs 192 per order

(Cost driver is number of times material is ordered.)

Activity based costing..


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Contd.

Material handling cost = handling cost / No. of times material handled.= Rs 7580/27

= Rs 280.74 per time material handled(Cost driver is number of times material handled)

Administration for spare parts = Rs 8,600/ 12=Rs 716.67


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Computation of overhead cost per product using ABC

0verhead items A BMachine overhead hour @ Rs 3/mc hr= Rs.

0.75

hour @ Rs 3/mc hr= Rs.

0.75

Set up cost (1 X Rs 256.18)/500volume=1.12

6X Rs 256.18)/5000volume=0.56

Material handling cost (1 X Rs 280.74)/500=0.38

(10X Rs 280.74)/5000=0.15

Material ordering cost (1 X Rs 192)/500=0.38

(4xRs.192)/5000=0.72

Administration forspare parts

(1 X Rs 716.67)/500=0.38

(5X Rs 716.67)/5000=0.717

Total overhead

cost/unita/c to ABC

5.63 2.49


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products Overhead costper unit basedon ABC

Overhead costbased on presentsys of machinehr rate ofRs.4.80 /hr

difference

A 5.63 1.20 +4.43

B 2.49 1.20 +1.29

C 6.67 4.80 +1.96

D 5.79 7.20 -1.41

Over head cost based on two system and their difference


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Benefits of implementing ABC:

Cost management and downsizing.

Determination of product and servicescost.

Improvement in performance.

Product/service pricing.

Make or buy decisions.

Transfer pricing.


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Substantial resourcesrequired to implement

and maintain.

Resistance tounfamiliar numbers

and reports.

Does not conform toGAAP. Two costing

systems may beneeded

Desire to fullyallocate all costs

to products

Potentialmisinterpretation ofunfamiliar numbers


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Conclusion:-

ABC may not be appropriate for all companies,particularly those where overheads are small andwhich do not produce a wide range of products.But many of the benefits of ABC can still be

obtained by implementing a partial system, whichfocuses on most important activities. Nor themethod should be used for preparing monthlyprofit statements. Traditional methods should beused for that, leaving ABC to support strategic

decision-making, profitability analysis and controlof manufacturing cost.


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THANK YOU..

Documents

Development of ABC System