Activity Based Costing

Q.1 what do mean by Activity Based Costing (ABC) System?

Ans: Activity based costing (ABC) which determines the cost of activities and provides
management with relevant and timely information. In this method of costing overhead is
allocated to the products using multiple cost drivers. This method reduces the risk of the
distortion and provides accurate cost information.
Q.2 Distinguish between Traditional Costing and Activity Based Costing.

Traditional Costing Activity Based Costing

Ans:

i) Costs are incurred for specific jobs, i) Costs are incurred for specific activities only.
products or operation.

ii) Various overhead absorption rates ii) Costs per unit of activity are ascertained.
are
calculated.
iii) Overheads are absorbed usually on the basis
iii) Overheads are absorbed usually on of no. of materials handling, number of inspection
the basis of Direct material cost, Direct of materials done, number of machine hours
labour cost, Direct labour hours worked, materials receipts etc.
worked, Machine hours worked, Prime
Cost etc. iv) Overheads are charged to jobs as per number
of units of various activities undertaken in
iv) Overheads are charged to job as per completing the job.
predetermined absorption rate.
v) There is greater scope of control of overheads.

v) There is less scope of control of vi) There is more accuracy in determining and
overheads. charging overheads to job.

vi) There is less accuracy in determining

and charging overheads to jobs.
Q.3 How is ABC Superior to Traditional Costing?
Ans: ABC system is advantageous over the traditional costing system for the following reasons:
i) It helps understanding the behaviour of overhead costs.
ii) It links profitability analysis and operational decision.
iii) It improves the competitive position of a business.
iv) It provides information for measurement of performance.
 v) It identifies inefficient products, departments and activities.
vi) It helps to identify necessary costs as cost drivers for each activity gets better control over

the factors that cause costs.

vii) It help to control costs for each product and for each department.
viii) It helps the management in fixing price of products and services scientifically.
Q.4 Explain the term ‘ Cost Driver’, with example in the context of ABC system.
Ans: Activity Based Costing determines the cost of activity. In this method of costing overhead
is allocated to the products using multiple cost drivers. ABC attempts to relate overhead cost
to the activities that cause or drive them the activities are termed as ‘Cost Drivers’, so a cost
Driver is any factor that has the effect of changing the level of total cost.
Example of cost Driver: Cost per machine hour worked, cost per purchase order, cost per
Set up etc.
Q.5 Write short notes on Cost Pool.
Ans: A cost pool represents a grouping of individual cost items. For Indirect or support
Department costs which need allocation to products or services such cost pools are to be
formed. A cost pool comprises cost that have the same or similar cause and effect relationship
with cost allocation base. A cost pool may be employed for every identified activity or sub-
activity. In fact a cost pool is a cost center. For example purchase department, machine shop,
materials handling dept. etc.
Q.6 Give three examples of Cost pool with its cost Drivers.
Ans: Cost pool
(a) Machine shop – Its cost driver is cost per machine hour worked.
(b) Purchase Dept – Its cost driver is cost per purchase order.
(c) Administration block – Its cost driver is computer hours order.
Q.7 Discuss the Disadvantages (Limitation/Drawback) of ABC.
Ans: Disadvantages of ABC:
(i) May be difficult to identify activities and cost drivers.
(ii) Based on simplification – may be difficult to allocate all costs to specific activities.
(iii) Can be difficult to understand.
 (iv) May become very complex and expensive to implement.
Q.8 A company manufactures two products P and Q using same

facilities and process. The cost data for April, 2012 are given
below :
Product Output Direct labour Machine Hour Total No Total No
Hours of orders
(units) (Per Unit) (Per unit) handled of set-ups
A 4,000 1 3 15 20
B 5,000 2 1 25 40
The overhead costs for the month are as follows : ₹
Relating to machine activity 1,70,000
Relating to production run set-ups 90,000
Relating to handling orders. 20,000
You are required to calculate the production overheads to be
absorbed one units of each the products A and B using the
following costing method :
(1) A traditional costing approach (using direct hour rate to
absorb overheads)
(2) An activity-based costing approach (using suitable cost
drives.)
Q.9 A company manufacturing two products X and Y furnishes the
following data for the year.
Product Annual Machine Direct labour Total no Total no of
output Hours hours of orders set-up
(units) (per unit) (pre unit) handle
X 8,000 3 5 15 10
Y 5,000 1 2 30 40
Annual overhead costs : Rs.
Relating to machine activity 2,90,000
 Relating to production run set-ups 40,000
Relating to handling orders. 45,000

________
3,75,000
You are required to calculate the production overheads to be
absorbed by one unit of the product X and Y using the following
costing methods :
(a) A traditional costing approach using a direct labour hour
rate to absorb overheads.
(b) An activity-based costing approach, using suitable cost
drivers to trace overheads to products.
Q.10 A company manufacturing two products furnishes the following
data for a year :
Product Annual output Total Machine No. of Purchase Total No.
(units) hours orders of set-up
X 5,000 20,000 160 20
Y 6,000 12,000 200 44
The annual cost are as under : Rs.
Volume related activity costs 4,80,000
Set-up related costs 6,40,000
Purchase related costs 7,20,000
_________
18,40,000
You are required to calculate the cost per unit of each Product
A and B based on :
(a) Traditional method of charging overheads.
(b) Activity-based costing methods.
Q.11 A company produces two products P and Q the following
particulars are available relating to these products :
 P Q
Sales in units 2,500 1,000

Labour hours per unit 2 2

Direct material cost per unit Rs.12.50 Rs.7.50
Direct labour cost per unit Rs.10.00 Rs.10.00
The company has analysed its operations and determinated five
activities as cost drivers in the incurrence of overhead costs.
Data relating to the five activities are given below :
Traceable costs No. of events
P Q
Machine set-ups 1,15,000 3,000 2,000
Quality inspection 80,000 5,000 3,000
Production orders 40,500 200 400
Machine hours worked 1,57,000 12,000 28,000
Material receipts 45,000 150 600
You are required to compute per unit cost for each unit of
product using :
(a) Direct labour hour rate method for absorption of overhead
costs.
(b) ABC technique for absorption of overhead costs.
Q.12 A Ltd. produces three products X, Y and Z, about which it has provided the following
information for a period :
Product X Product Y Product Z
Units produced 200 200 200
Materials moves per production line 40 50 60
Direct Labour Hours 2,000 2,000 2,000
‘Budgeted Materials handling cost ₹ 18,00,000
You are to ascertain:
(a) Material Handling Cost per units of products using Absorption Costing Method.
 (b) Material Handling Cost per units of products by using Activity Based Costing Method.
Q.13 A manufacturing company gives you the following information relating to its product lines.

X Y
Number of units to be produced 150 50
Machine set up hours per product line 10 10
Direct labour hours per units 2 2
The budgeted machine set up cost is ₹ 14,400
You are required to:
(a) Allocate machine set up related cost to product line X and Y using direct labour hour
rate.
(b) allocate machine set up related cost to the product lines using Activity Based Costing.
Q.14 A manufacturing company produces two products i.e., X and Y. The particulars relating to
Two products are given below:
Product X Product Y
Direct material cost per unit Rs.10 Rs.12
Direct wages per unit Rs.10 Rs.8
Units produced 200 200
Direct labour hours per unit 12 12
Material moves per product line 10 14
Budgeted material handling cost(overhead cost) Rs.24,000
(i) Determine cost per unit of the products using volume based allocation method
(Direct labour hour rate)
(ii) Determine cost per unit of the products using Activity Based Costing.