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Learning Objectives
 Concept of Activity Based Costing (ABC)
 Significant Terms: Cost Objectives, Activities, Cost
Pool and Cost Drivers
 Steps Involved in ABC
 Use of Activity Based Information
 Activity Based Costing Vs. Trading Costing
 Solved Practical Problem
 Practice Questions with Answer

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Traditional Method of Absorption
 In traditional method of overhead absorption, a
general or blanket rate is used, which is volume
based. For example:
 Factory overheads as a on direct
percentage material/direct labour or
prime cost,
 Labour hour rate or machine hour rate.

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 Activity Based Costing (ABC)
 According to Cooper and Kalpan, “ABC (Activity based costing)
system calculate the costs of individual activities and assign costs
to cost objects such as products and services on the basis of
activities undertaken to produce each product or service.”

 Activity based costing (ABC) is a method of assigning (or

absorbing) overheads to end products and services on the
basis of benefits received by the products and services
from indirect activities, instead of using a blanket rate of
absorption.

 Production activities are divided into major activities,

which are used as a cost center, Overheads cost are
pooled at these center and then overhead rates are
calculated per activity. And then these rates are applied to
charge overheads to end products.
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Significant Terms
 Cost Objects: Generally the products are cost objects, but
Customers, services or locations may also be the cost
objects.
 Activities: Activities are of two types: (a) Production
activities, like manual and mechanical process, assembly
and (b) Support Activities, like, purchase, storage, repairs
and maintenance, etc.
 Cost Pool: Cost pool is an activity cost center at which
costs are pooled.
 Cost Drivers: Cost driver may be defined as a factor or
cause for incurrence of overhead costs. For example:
machine our, number of purchase orders, number of set-
ups, etc.

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Examples of Activity Cost Drivers
 For purchase of materials: number of purchase
orders, number of receipts of materials, number of
inspections.
 For setting-up of machines: number of set-ups or
number of set-up hour
 For production activity: machine hours or labour
hour
 For repairs and maintenance activity: Number of
service calls, time spent in repairs and maintenance.

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Steps Involved in ABC
 Identify significant activities
 Calculate the total cost of each activity (i.e. cost pool)
 Determine the appropriate activity cost driver for each
activity
 Calculate the activity cost driver rate:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑎𝑛 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

=
𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑑𝑟𝑖𝑣𝑒𝑟 𝑣𝑜𝑙𝑢𝑚𝑒
 Charge activity cost to end products, jobs or services:
Activity cost to be charged= Activity consumed
×
𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑑𝑟𝑖𝑣𝑒𝑟 𝑟𝑎𝑡𝑒
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Use of Activity Based Information
 Focus on the factors or causes of the cost
 Helps in ascertaining accurate product cost due to
understanding the cost behavior
 Focus on value-added activities
 Provides strategic cost information, which helps in
long-term pricing and profitability decisions
 Improved cost basis

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 Activity Based Costing Vs Traditional Costing

 Effectiveness of purpose: ABC method serves

the objectives of product costing and pricing
decisions more effectively.
 Basis of identification: Activites Vs Department:
Under traditional costing method overheads are
attributed to a department while under ABC system,
overheads are attributed to major activities
performed in the department.
 Terms used: Under ABC system, ‘cost drivers’ are
used for major activities for overhead absorption,
while traditional method uses a blanket rate.
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DU B. Com. (H) 2006 &2013
A Company manufacturing two products furnishes the following data for a year:

Products annual output total machine total number of total number of

(units) hours purchase set-ups
orders

A 5,000 20,000 160 20

B 60,000 1,20,000 384 44

The annual overheads are as under:
 Volume related activity cost 5,50,000
 Setup related cost 8,20,000
 Purchase order related cost 6,18,000
You are required to calculate the cost per unit of each product A and B based on
(i) traditional method of charging overheads and (ii) activity based costing
method.

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Solution:
Total Overheads = 5,50,000 + 8,20,000 + 6,18,000 =
19,88,000
Total Machine Hours = 20,000 + 120,000 = 1,40,000
Total Number of Purchase Orders = 160 + 384 =
544 Total Number of Set-ups = 20 + 44 = 64
1. Traditional Method of charging Overheads
𝑇𝑜𝑡𝑎𝑙 𝐴 𝑛 𝑛 𝑢 𝑎 𝑙
Machine Hour Rate (General) 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎 𝑐ℎ𝑖𝑛𝑒
= 19,88,000 𝐻𝑜𝑢𝑟𝑠
= = 14.20 per hour
1,40,000

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 Solution:
Total Overheads = 5,50,000 + 8,20,000 + 6,18,000 = 19,88,000
Total Machine Hours = 20,000 + 120,000 = 1,40,000
Total Number of Purchase Orders = 160 + 384 = 544
Total Number of Set-ups = 20 + 44 = 64
1. Traditional Method of charging Overheads
𝑇𝑜𝑡𝑎𝑙 𝐴 𝑛 𝑛 𝑢 𝑎 𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 19,88,000
Machine Hour Rate (General) = = =
𝑇𝑜𝑡𝑎𝑙 𝑀 𝑎 𝑐 ℎ𝑖 𝑛 𝑒 𝐻 𝑜 𝑢 𝑟 𝑠

1,40,000
14.20 per hour
2. Activity Based Costing
(a) For Volume related Costs, Machine Hour Rate
𝑇𝑜𝑡𝑎𝑙 𝐴 𝑛 𝑛 𝑢 𝑎 𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑣 𝑜 𝑙 𝑢 𝑚 𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 5,50,000
= = = 3.93 per hour
𝑇𝑜𝑡𝑎𝑙 𝑀 𝑎 𝑐 ℎ𝑖 𝑛 𝑒 𝐻 𝑜 𝑢 𝑟 𝑠 1,40,000
(b) For set-up related Costs, Set-up Rate
𝑇𝑜𝑡𝑎𝑙 𝐴 𝑛 𝑛 𝑢 𝑎 𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑠𝑒𝑡−𝑢𝑝 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 8,20,000
= = =
𝑇𝑜𝑡𝑎𝑙 𝑛 𝑢 𝑚 𝑏 𝑒 𝑟 𝑜 𝑓 𝑠𝑒𝑡−𝑢𝑝𝑠 64 12
(c) For purchase related Costs, Overheads per purchase
order
𝑇𝑜𝑡𝑎𝑙 𝐴 𝑛 𝑛 𝑢 𝑎 𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
=
6,18,000
𝑇𝑜𝑡𝑎𝑙 𝑛 𝑢 𝑚 𝑏 𝑒 𝑟 𝑜 𝑓 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑟𝑑𝑒𝑟𝑠
= 544
= 1,136.03 per order

A) Statement of Overhead Cost Per Unit (Traditional Method)

Products Annual Total machine Overhead Costs Overhead Cost

Output Hours per unit

A 5,000 20,000 20,000 x 14.20 2,84,000/5,000

= 2,84,000 = 56.80
B 60,000 1,20,000 1,20,000 x 14.20 17,04,000/60,000
= 17,04,000 = 28.40

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B) Statement of Overhead Cost Per Unit (Activity Based Costing
Method)
Product and Overheads Costs Overhead cost
Annual Output per unit
A (5,000 units) Cost related to Volume 20,000 x 3.93
activities = 78,600
Cost related to Purchases 160 x 1,136.03
= 1,81,765
Cost related to set-ups 20 x 12,812.5
= 2,56,250
Total Overheads Costs 5,16,615 5,16,615/5,000
= 103.32
B (60,000 units) Cost related to Volume 1,20,000 x 3.93
activities = 4,71,600
Cost related to Purchases 384 x 1,136.03
= 4,36,236
Cost related to set-ups 44 x 12,812.5
= 5,63,750
Total Overheads Costs 14,71,586 14,71,586/60,000
= 24.53

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DU B. Com. (H) 2012
A company manufactures two products A and B using common
facilities. the following cost data for a month are presented to
you:Product Units Direct Machine Set-ups of Orders
Labour Hours
produced Hours per per machines
unit unit
A 1,000 2 6 15 18
B 2,000 3 1.5 50 70

 Machine activity expenses 3,00,000

 Setup related expenses 30,000
 Expenses related to orders 35,000
Calculate the overheads per unit absorbed using activity based
costing approach.

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DU B. Com. (H) 2012 – Detailed Answer
(a) For machine related Costs, Machine Hour Rate
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑚 𝑎 𝑐 ℎ𝑖 𝑛 𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 3,00,000
= = = 33.33 per hour
𝑇𝑜𝑡𝑎𝑙 𝑀 𝑎 𝑐 ℎ𝑖 𝑛 𝑒 𝐻 𝑜 𝑢 𝑟 𝑠 9,000
(b) For set-up related Costs, Set-up Rate
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑠𝑒𝑡−𝑢𝑝 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 30,000
= = = 461.54 per set-up
𝑇𝑜𝑡𝑎𝑙 𝑛 𝑢 𝑚 𝑏 𝑒 𝑟 𝑜 𝑓 𝑠𝑒𝑡−𝑢𝑝𝑠 65
(c) For order related Costs, Overheads per order
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑜𝑟𝑑𝑒𝑟 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 35,000
= = = 397.73 per order
𝑇𝑜𝑡𝑎𝑙 𝑛 𝑢 𝑚 𝑏 𝑒 𝑟 𝑜 𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 88
(d) Overhead cost per unit (Product A) = 214.08 (200+6.92+7.16)
(e) Overhead cost per unit (Product B) = 75.46 (50+11.54+13.92)

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DU B. Com. (H) 2011
Major Limited manufactures two products a and b. the product is low
volume atom and its sales are only 5,000 units per annum. the product B is a
high volume item and sales are 20,000 units per annum. both products
required to direct labour hours for completion. the company works 50,000
direct labour hours each year as given below:
 Poduct A : 5000 units x 2 hours = 10,000 hours
 Product B: 20,000 x 2 hours = 40,000 hours
Details of cost for material and labour for each product (per unit) are
given below:
 Direct materials: Product A – 25 and Product B – 15
 Direct labour @ 5 per hour : Product A – 10 and Product B – 10
The company's total manufacturing overhead costs are 8,75,000 per annum.
The company has analysed its operations and has determined the five
activities act as cost drivers in the incurrence of overhead costs. Data relating
to the five activities are as follows:
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DU B. Com. (H) 2011 (Continued)
A company manufactures two products A and B using common facilities. the
following cost data for a month are presented to you:
Activity Traceable Number of events or transactions
costs ()
Total Product A Product B
Machine set-ups 2,30,000 5,000 3,000 2,000
Quality Inspections 1,60,000 8,000 5,000 3,000
Production Orders 81,000 600 200 400
Machine hours worked 3,14,000 40,000 12,000 28,000
Materials Receipts 90,000 750 150 600
Total 8,75,000
You are required to computer per unit cost for each product using (i) direct
labour hour rate method for absorption of overhead cost and (ii) activity
based costing technique for absorption of overhead cost comment on your
results.
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DU B. Com. (H) 2011 – Detailed Answer
(1) Computation of product cost using direct labour hour
rate 8,75,000
=
𝑇𝑜𝑡𝑎𝑙 𝑚 𝑎 𝑛 𝑢 𝑓 𝑎 𝑐 𝑡 𝑢 𝑟 𝑖 𝑛 𝑔
𝑇𝑜𝑡𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿 𝑎 𝑏 𝑜 𝑢 𝑟 𝐻 𝑜 𝑢 𝑟 𝑠
= 50,000
= 17.50 per hour
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
Product cost per unit (Product A) = 70 (DM 25+DL 10 + Overheads
35) Product cost per unit (Product B) = 60 (DM 15+DL 10 +
Overheads 35)
(2) Computation of product cost using ABC
(i) Cost per set-up = 46
(ii) Cost per inspection = 20
(iii) Cost per production order = 135
(iv) Cost per machine hour worked = 7.85
(v) Cost per material receipt = 120
Overhead cost per Unit = Product A – 75.44 and Product B – 24.89
Product cost per unit (A) = 110.44 (DM 25+DL 10 + Overheads
75.44) Product cost per unit (B) = 49.89 (DM 15+DL 10 + Overheads
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24.89)
THANKS

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