Assignment Atul Sharma

8/8/2019 Assignment Atul Sharma

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Assignment:- Cost Accounting

Define Activity-Based Costing

Differentiate ABC & Through put costing

Explain procedure of ABC with example

Submitted by:-Atul SharmaL-2010-BS-03-MBA


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Introduction

Cost accounting:-A type of accounting process that aimsto capture a company's costs of production by assessingthe input costs of each step of production as well as

fixed costs such as depreciation of capital equipment.

Cost accounting will first measure and record these costsindividually, then compare input results to output oractual results to aid company management in measuring

financial performance.


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Need of different cost

accounting systems

To compete successfully, companies

must change the way they report and

manage costs. This means replacing

old institutions of cost accounting and

inventory valuation.


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Requirement of Cost Systems

Valuation of inventory and measurement of thecost of goods sold for financial reporting.

Estimation of the costs of activities, products,services, and customers.

Providing economic feedback to managers andoperators about process efficiency.


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Conventional Costing

Total Cost = Material + Labour+ Overheads

Overheads are allocated to the products onvolume based measures e.g. labour hours,machine hours, units produced


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Will this not distort the costing in

the new environment?

Due to the historic background of traditionalcost accounting methods, they tend to use

direct labor - or other volume related allocationbases - for cost assignment purposes.

But as overhead has grown and new

technologies have come, it goes without sayingthat assigning costs based on only 5 - 15% (inmost companies) of total costs is highly risky.


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ABC provides an Alternative.

Costs are assignedaccording to the'cause and effectrelationship betweenactivities (the actualprocess) and cost objects,

which is captured usingdrivers.


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Activity based costing (ABC)

Activity-based costing (ABC) is a costing model thatidentifies activities in an organization and assigns thecost of each activity resource to all products and services

according to the actual consumption by each

In this way an organization can precisely estimate thecost of its individual products and services for thepurposes of identifying and eliminating those which are

unprofitable and lowering the prices of those which areoverpriced.


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Basics of Activity based costing

Cost of a product is the sum of the costs of allactivities required to manufacture and deliverthe product.

Products do not consume costs directly

Money is spent on activities

Activities are consumed by product/services


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Basics of Activity based

costing (cont) ABC assigns Costs to Products by tracing expenses to

activities. Each Product is charged based on the extentto which it used an activity

Provides ways of assigning the costs of indirect supportresources to activities, business processes, customers,products.

It recognizes that many organizational resources arerequired not for physical production of units of productbut to provide a broad array of support activities.


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Defining resource drivers

Resource drivers measure the demands placedon resources by activities and are used toassign costs of resources to activities.

Example: Consider the activity of maintainingequipment. This activity consumes resourcessuch as parts, equipment, tools, labour, and

energy (power to run the equipment andtools).


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Defining activity drivers

The linkage between activities and cost

objects, such as products, customers, isaccomplished by using activity drivers.

An activity driver is a quantitative measure of

the output of an activity.


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Activities: Types

Unit level: Performed each time a unit isproduced

Batch level: Performed each time a batch isproduced

Product level: Performed to support productionof different type of product

Customer Level: Performed to supportservicing customers

Facility level: Residuary head


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Building an ABC model

Identify

Resources

Identify

Activities

Identify

Cost Objects

Define

Resource

Drivers

Define

Activity

Drivers

Enter

Resource

Costs

Enter

Resource

Driver Qty.

Enter

Activity

Driver Qty.

Calculate

Costs


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ABC vs Throughput accounting A costing methodology that focuses on capacity

utilization is called "throughput costing

An accounting method that allocates costs tospecific products or services or activities suchas production, delivery or maintenance basedon breakdowns of cost drivers is called ABC


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Example

We will assume that a company has annualmanufacturing overhead costs of $2,000,000

of which $200,000 is directly involved insetting up the production machines. During theyear the company expects to perform 400machine setups. Lets also assume thatthe batch sizes vary considerably, but the

setup efforts for each machine are similar.


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Example (Cont)

The cost per setup is calculated to be $500 ($200,000 ofcost per year divided by 400 setups per year). Underactivity based costing, $200,000 of the overhead will beviewed as a batch level cost. This means that $200,000

will first be allocated to batches of products to bemanufactured, and then be assigned to the units ofproduct in each batch. For example, if Batch X consistsof 5,000 units of product, the setup cost per unit is$0.10 ($500 divided by 5,000 units). If Batch Y is50,000 units, the cost per unit for setup will be $0.01

($500 divided by 50,000 units). For simplicity, letsassume that the remaining $1,800,000 of manufacturingoverhead is caused by the production activities thatcorrelate with the companys 100,000 machine hours.


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Example (Cont)

For our simple two-activity example, let's see how therates for allocating the manufacturing overhead wouldlook with activity based costing and withoutactivitybased costing


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Example (Cont)

Next, let's see what impact these different allocationtechniques and overhead rates would have on the per unit costof a specific unit of output. Assume that a companymanufactures a batch of5,000 units and it produces 50 units

per machine hour, here is how the cost assigned to the unitswith activity based costing and without activity based costingcompares:


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Example (Cont)

If a company manufactures a batch of50,000 units andproduces 50 units per machine hour, here is how the costassigned to the units with ABC and without ABC compares:


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Result

With activity based costing the cost per unit decreases from$0.46 to $0.37 because the cost of the setup activity is spreadover 50,000 units instead of 5,000 units.

Without ABC, the cost per unit is $0.40 regardless of thenumber of units in each batch. If companies base their selling

prices on costs, a companynot

using an ABC approach mightlose the large batch work to a competitor who bids a lowerprice based on the lower, more accurate overhead cost of$0.37.

Its also possible that a company not using ABC may find itselfbeing the low bidder for manufacturing small batches ofproduct, since its $0.40 is lower than the ABC model of $0.46for a batch size of 5,000 units.

With its bid price based on manufacturing overhead of $0.40but a true cost of $0.46the company may end up doing lotsof production for little or no profit.


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THANK YOU

Assignment Atul Sharma

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