Managerial Accounting

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Activity Based Costing

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Assignment (Case Study on ABC costing)
Prepared For: Shabbir Mubin (SBR)
Course: ACT 202
Sec: 07

Prepared By:

Name: Md. Motiur Rahman Name: Iftekhar Zakaria
ID: 0920012030

ID: 0930323030

Name: Safayet Amin

Name: Zayn Faiyaz Alamgir

ID: 0920422030

ID: 0930378530

Name: Rahimul Anam
ID: 0930205030

Question No. 1:

What is Activity Based Costing? Discuss the Activity Based
Costing Method.
Answer to Question No. 1:

Activity Based Costing (ABC) is an alternative to the traditional way of accounting.
Traditionally it is believed that high volume customers are profitable customers, a
loyal customer is also a profitable one, and profits will follow a happy customer.
Studies of customer profitability have unveiled that the above is not necessarily true.
ABC is a costing method that identifies the cost pools, or activity centers in an
organization and assigns costs to products and services (cost drivers) based on the
number of events or transactions involved in the process of providing a product or
service. As a result, ABC method can support managers to see how to maximize
shareholder value and improve corporate performance.
ABC is ordinarily used as a supplement to, rather than as a replacement for a
company’s usual costing system. Most organizations that use ABC method have two
costing systems – the official costing system that is used for preparing external
financial reports and the ABC system is used for internal decision making and for
managing activities.

Historical Development of ABC Method:
Traditionally cost accountants randomly added a broad percentage of expenses into
the indirect cost. However as the percentage of indirect or overhead cost rose, this
technique became increasingly inaccurate, because indirect cost were not caused
equally by all products.
ABC is based on George Staubus' Activity Costing and Input-Output Accounting.
The concepts of ABC were developed in the manufacturing sector of the United States
during 1970s and 1980s. Instead of using broad arbitrary percentages to allocate costs,
ABC seeks to identify cause and effect relationships to objectively assign costs. Once
costs of the activities have been identified, the cost of each activity is attributed to
each product to the extent that the product uses the activity. In this way ABC often
identifies areas of high overhead costs per unit and so directs attention to finding ways
to reduce the costs or to charge more for costly products.

Activity-based costing was first clearly defined in 1987 by Robert S. Kaplan and
W.Bruns as a chapter in their book “Accounting and Management: A Field Study
Perspective’’. They initially focused on manufacturing industry where increasing
technology and productivity improvements have reduced the relative proportion of the
direct costs of labor and materials, but have increased relative proportion of indirect
costs. For example, increased automation has reduced labor, which is a direct cost, but
has increased depreciation, which is an indirect cost.
Activity-based costing was later explained in 1999 by Peter F. Drucker in the book
“Management Challenges of the 21st Century”. He states that traditional cost
accounting focuses on what it costs to do something, for example, to cut a screw
thread; activity-based costing also records the cost of not doing, such as the cost of
waiting for a needed part. Activity-based costing records the costs that traditional cost
accounting do not.

Steps To Carry Out ABC Method:
1. Identify and define activities and activity cost pools.
2. Wherever possible, directly trace costs to activities and cost objects.
3. Assign costs to activity cost pools.
4. Calculate activity rates.
5. Assign costs to cost objects using the activity rates and activity measures.
6. Prepare management reports.

Activity based costing is a costing technique based on an analysis of the resources
actually used to produce a product or provide a service. It takes into account, actual
direct material cost, direct labor cost, and both manufacturing and non-manufacturing
overhead costs incurred to produce the product or service. It also defines five levels of
activity that largely do not relate to the volume of units produced. They are described
below:
1.

Unit-level activities are carried out each time a unit is produced. The unit level
cost is proportional to the number of unit produced. For example – providing a
power to run processing equipment would be unit level activity.

2.

Batch-level activity is performed each time a batch is handled, regardless of how
many units are in the batch. For example – tasks such as placing purchase orders,
setting up equipment and arranging for shipments to customers are batch-level
activities.

3.

Product-level activities relate to specific products and typically must be carried
out regardless of how many batches are run or units of product are produced or

sold. For example – activities such as designing a product, advertising a product
and maintaining a product manager and staff are all product- level activities.
4.

Customer-level activity relate to specific customers and include activities such
as sells calls, catalog mailings and general technical support that are not tied to
any specific product.

5.

Organization-sustaining activities are carried out regardless of which
customers are served, which products are produced, how many batches are run,
or how many units are made. For example – heating the factory, cleaning
executive offices etc.

Cost driver:

A cost driver is the unit of an activity that causes the change of an activity cost. A
cost driver is any activity that causes a cost to be incurred. Cost drivers determine the
cost behavior within the activities, reflecting the links that these have with other
activities and relationships that affect them. A cost driver is also referred to an activity
measure. There are two most common types of cost driver, they are:


Transaction drivers are simple counts of the number of times an activity occurs
such as the number of bills sent out to customers.



Duration driver measures the amount of time required to perform an activity
such as the spent to prepare individual bills for customers.

Question No. 2:

Using the information in the text and in Exhibit 2, calculate
“ABC” based services cost for the TFC business.
Answer to Question No. 2:

Activity Based Costing :
Activity
Cost Pools

Total
Cost

Total
Activity

Activity
Rate

Storage
Requisition handling
Basic warehouse stock selection
Pick-pack activity
Data entry
Desk top delivery
Cost of capital on monthly inventory balance
Annual freight charge

1550000
1801000
761000
734000
612000
250000

350000
310000
775000
697500
775000
8500
-

4.43
5.81
0.98
1.05
0.79
29.4
13
Actual

57,08,000

Question No. 3:

Using your new costing system, calculate distribution services
costs for “Customer A” and “Customer B”.
Answer to Question No. 3:

Activity Based Costing System for ‘Customer A’ :
Activity
Cost Pools

Activity
Rate

Activity

ABC
costing

Storage
Requisition handling
Basic warehouse stock selection
Pick-pack activity
Data entry
Desk top delivery
Cost of capital on monthly inventory balance
Annual freight charge

4.43
5.81
0.98
1.05
0.79
29.4
13
Actual

350
364
910
910
910
15,000
-

1,550.5
2115
891.8
955.5
718.9
1,950
2,250
10,431.7

Activity Based Costing System for ‘Customer B’ :
Activity
Cost Pools

Activity
Rate

Activity

ABC
costing

Storage
Requisition handling
Basic warehouse stock selection
Pick-pack activity
Data entry
Desk top delivery
Cost of capital on monthly inventory balance
Annual freight charge

4.43
5.81
0.98
1.05
0.79
29.4
13
Actual

700
790
2500
2500
2500
26
50,000
-

3,101
4,590
2,450
2,625
1,975
764.4
6,500
7,500
29,505.4

Question No. 4:

What inference do you draw about the profitability of these two
customers?
Answer to Question No. 4:

Customer Margin :
Details

A

B

Sales

79,320

79,320

Less: Cost of product
Storage
Requisition handling
Basic warehouse stock selection
Pick-pack activity
Desk top delivery
Data entry
Freight cost
Cost of capital on monthly inventory
balance
Customer Margin

(50,000)
(1,550.5)
(2115)
(891.8)
(955.5)
(718.9)
(2,250)
(1,950)

(50,000)
(3,101)
(4590)
(2,450)
(2,625)
(764.4)
(1,975)
(7,500)
(6,500)

18,888.3

(185.4)

By using the new costing system for calculating the distribution services costs, we can
see that the customer margin for customer A is $18,888.3 and for customer B is ($
185.4). The reason behind customer B's poor margin is due to higher average
monthly inventory balance which was $ 50,000, while for customer A was $ 15,000
and also higher cost of capital on monthly inventory balance ( which is $6,500 for
customer A and $1,950 for customer B ). Also due to greater activity on customer
B's account, a shipment went out three times a week at an annual freight cost of $
7,500 while customer A required only one shipment a week at an annual freight cost
of $ 2250. In addition to the above, customer B has ordered 26 Desktop delivery
(which costs $764.4) during the past year compared to customer A, who ordered
none. We also see that customer B has a higher storage cost ( $ 3,101 ) then customer
A ( $ 1,550.5 ). Due to the above stated factors, we see that customer A is enjoying a
profit, on the other hand customer B isn’t.

Reference for this Assignment focusing on Activity based costing
system

Articles:
1. www.cfo.com/article.cfm/3007694
2. www.articlebase.com

Text book:
1. Managerial Accounting 13th Edition by Garrison and Noreen
Publishers: McGraw-Hill Irwin

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