CA.CS.CMA.MBA: Naveen.

Rohatgi Cost Accounting for Engineers

ACTIVITY BASED COSTING

1. MEANING OF ACTIVITY BASED COSTING

Definition:
CIMA defines Activity Based Costing as, ‘cost attribution to cost units on the basis of benefit
received from indirect activities e.g. ordering, setting up, assuring quality.’
Another definition of Activity Based Costing is, ‘the collection of financial and operational
performance information tracing the significant activities of the establishment to product costs.’
Objectives of Activity Based Costing
1. To remove the distortions in computation of total costs as seen in the traditional costing
system and bring more accuracy in the computation of costs of products and services.
2. To help in decision making by accurately computing the costs of products and services.
3. To identify various activities in the production process and further identify the value adding
activities.
4. To distribute overheads on the basis of activities.
5. To focus on high cost activities.
6. To identify the opportunities for improvement and reduction of costs.
7. To eliminate non-value adding activities.

2 STEPS IN ACTIVITY BASED COSTING

The steps in Activity Based Costing are explained below.

1. Understanding and analyzing manufacturing process: -

For installation of any costing system, study of manufacturing process is essential. For
Activity Based Costing system also, it is necessary to study the manufacturing process and
ascertain various stages involved in the product or service so that ‘activities’ involved in that can
be identified.

2. Study of the Activities involved: -

The next step is to study the activities involved in the manufacturing process. In this step,
the activities involved in a process are identified. In case of a manufacturing company, purchase
procedure may involve activities like receiving of purchase requisition for concerned department
or the stores department, inviting quotations from various suppliers, placing of an order, follow
up of the same and finally receiving and inspection of the goods. Next step is to divide the
activities into value adding and non-value adding. The objective behind this is that attention can
be focused on the value adding activities while non-value adding activities can be eliminated in
the future.

3. Activity Cost Pool:-

 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Cost pool is defined by CIMA as, ‘the point of focus for the costs relating to a particular
activity in an activity based costing system.’ For example, in case of a manufacturing organisation,
as regards to stores, cost of classification, cost of issue of stores requisitions, inspection costs etc.
can be pooled under the heading ‘stores’. Thus cost pool concept is similar to the concept of cost
center. The cost pool is the point of focus or in other words, it is the total cost assigned to an
activity. It is the sum of all the cost elements assigned to an activity.

4. Cost Drivers:-

According to CIMA, ‘cost driver is any factor which causes a change in the cost of an activity,
e.g. the quality of parts received by an activity is a determining factor in the work required by that
activity and therefore affects the resources required. An activity may have multiple cost drivers
associated with it.’ In other words, cost driver means the factors which determine the cost of an
activity. For example, in stores, no. of stores requisitions will be cost drivers, in customer order
processing the no. of customers as well as no. of orders will be cost drivers Thus a cost driver is
an activity which generates cost. Activity Based Costing is based on the belief that activities cause
costs and therefore a link should be established between activities and product. The cost drivers
thus are the link between the activities and the cost.

5. Identification of costs with the products:-

The final step in Activity Based Costing is to identify the cost with the final products which
can also be called as cost objects. Cost objects include, products, services, customers, projects and
contracts.

As mentioned earlier, direct costs can be identified easily with the products but the indirect
costs can be linked with the products by identifying activities and cost drive` Thus Activity Based
Costing is the process of tracing costs first from resources to activities and then from activities to
specific products.

3. LIMITATIONS OF ACTIVITY BASED COSTING :

1. Activity Based Costing is a complex system and requires lot of records and tedious
calculations.
2. For small organisations, traditional cost accounting system may be more beneficial than
Activity Based Costing due to the simplicity of operation of the former.
3. Sometimes it is difficult to attribute costs to single activities as some costs support several
activities.
4. There is a need of trained professionals who are limited in number.
5. This system will be successful if there is a total support from the top management.
6. Substantial investment of time and money is required for the implementation of this system.
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Illustration 1
Bombay Steel Ltd. manufactures four products, namely A, B, C and D, using the same plant
and process. The following information relates to a production period:
Product Volume Material Direct Machine Labour Cost
Cost Per labour time Per unit
unit (Rs.) Per unit Per unit
A 500 5 1 /2 hour 1 /4 hour 3
B 5,000 5 1 /2 hour 1 / 4 hour 3
C 600 16 2 hours 1 hour 12
D 7,000 17 1–1/2 1- 1 / 2 9
hours hours

Total production overhead recovered by the cost accounting system is analysed under the
following headings:
Factory overhead applicable to machine- oriented activity 37,424
Set-up costs 4,355
Cost of ordering materials 1,920
Handling materials 7,580
Administration for spare parts 8,600

These overhead costs are absorbed by products on a machine hour rate of Rs. 4.80 per
hour giving an overhead cost per product of:

A = Rs. 1.20 B = Rs. 1.20 C = Rs. 4.80 D = Rs. 7.20

However, investigation into the production overhead activities for the period reveals the
following totals:
Product Number of Number of Number of times Number of
set-ups material material was spare parts
Orders handled
A 1 1 2 2
B 6 4 10 5
C 2 1 3 1
D 8 4 12 4

You are required:

1. To compute an overhead cost per product using Activity Based Costing, tracing overheads to
production units to means of cost drivers.

2. To comment briefly on the differences disclosed between overheads traced by the present
system and those traced by Activity Based Costing.

Solution:
1. Allocation of overheads based on machine hours rate. (Traditional Method)
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Total Overheads
Machine hours rate = no. of Machine hours =

59,879
= Rs. 4.8 per hour
12,475

No. of machine hours

A = (500 units x 1/4) = 125
B = (5,000 units x 1/4) = 1,250
C = (600 units x 1) = 600
10,00
D = (7,000 units x 1.5) = 12,475
Allocation of overheads based on Machine hours
A = (125 hours x 4.80) = 600
B = (1,250hours x 4.80) = 6,000
C = (600 hours x 4.80) = 2,880
D = (10,500 hours x 4.80) = 50,400
59,880
2. Allocation of overheads based on activity based costing
No Overheads Cost driver Cost driver per unit
1 Factory overheads machine hour 37,424 /
12,475

= Rs. 3 per hour

=Rs. 3 per hour

2 Setup Costs no. of setups 4,355 /

17

= Rs. 256.18 per setup

=256.18 per set up
3 Ordering materials no. of material ordering 1920/ 10
= 192 per order
4 Handling Materials no. of times material 7580/ 27 = 280.74 per time

7,580 /
27
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

was handled

5 Administration for spare No of spare parts 8600/ 12= 716.67 per spare
parts
parts

Particulars A B C D
1) Factory Cost (125 x 3) = 375 (1,250 x 3) (600 x 3) (10,500 x 3)
= 3750 = 1,800 = 31,500
2) Setup Cost (1 x 256.18) (6 x 256.18) (2 x 256.18) (8 x 256.18)
=256 = 1,537 = 512 = 2,050
3) Ordering Materials (1 x 192) (4 x 192) (1 x 192) (4 x 192)
= 192 = 768 = 192 = 768
4) Handling Materials (2 x 280.74) (10 x 280.74) (3 x 280.74) (12 x 280.74)
= 561 = 2,807 = 842 = 3,370
5) Admin for spare parts (2 x 716.67) (5 x 716.67) (1 x 716.67) (4 x 716.67)
= 1,433 = 3,583 =716 = 2,868
Total overheads as per activity based
costing 2,817 12,445 4,062 40,556
Total overheads as per traditional
method 600 6,000 2880 50,400

Allocation of overheads based on cost drivers

It will be seen that in this example there are significant differences between the costs using the
two systems. The costs of product A,B, C are much higher using ABC, whereas product D is lower.
ABC is more logical and precise than allocation of overheads under traditional machine hour rate
method
Illustration 2:
Having attended a CIMA course on Activity Based Costing (ABC) you decide to experiment
by applying the principles of ABC to the four products currently made and sold be your company.
Details of the four products and relevant information are given below for one period:
Product A B C D
Output in units 120 100 80 120
Cost per unit Rs. Rs. Rs. Rs.
Direct material 40 50 30 60
Direct labour 28 21 14 21
Machine hours (per unit) 4 3 2 3
The four products are similar and are usually produced in production runs of 20 units and
sold in batches of 10 units. The production overhead is currently absorbed by using a machine
hour rate, and the total of the production overhead for the period has been analyzed as follows:
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Machine departments costs (rent, business, rates, depreciation and supervision) 10,430 You
Set –up costs have
Stores receiving 5,250 ascertained
Inspection / Quality control 3,600
that the “cost
Materials handling and dispatch 2,100
drivers” to be
4,620
used are as
listed below for the overhead costs shown:
Cost Cost Driver
Set – up costs Number of production runs
Stores receiving Requisitions raised
Inspection / Quality control Number of production runs
Materials handling and dispatch Orders executed

The number of requisitions raised on the stores was 20 for each product and the number
of orders executed was 42, each order being for a batch of 10 of a product.
You are required:
i. To calculate the total costs for each product if all overhead costs are absorbed on a machine
hour basis;
ii. To calculate the total costs for each product, using activity based costing;
iii. To calculate and list the unit product costs from your figures in (a) and (b) above, to show
the differences and to comment briefly on any conclusions which may be drawn which could
have pricing and profit implications.
Solution :
1. Allocation of overheads based on traditional method
Total Overheads
Machine hours = no. of machine hours =
26,000
1,300
= Rs. 20 per hour
A = (120 x 4) = 480
B = (100 x 3) = 300
C = ( 80 x 2) = 160
D = (120 x 3) = 360
1,300

2. Allocation of overheads based on machine hour

A = (480 x 20) = 9,600
B = (300 x 20) = 6,000
C = (160 x 20) = 3,200
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

D = (360 x 20) = 7,200

26,000
2. Allocation of overheads based on activity based costing
No Overheads Cost Driven Cost Driver per
unit
1 Machine dept. cost no. of machine hour 10,430 / 1,300 =
Rs. 8.02 per hour

2 Setup Costs no. of production run 5,250 / 21 = 250 per

set up

3 Stores receiving no. of requisition raised 3,600/80= Rs 45

per requisition
4 Inspection / quality no. of production run 2,100/100= Rs
control 100 per run
5 Material handling & no. of order executed 4,620/42= Rs
dispatch 110 per order

WN: No. of Production run

A= (120 / 20) =6
B= (100 / 20) =5
C= (80 / 20) = 4
D= (120 / 20) = 6
21
Allocation of overheads based on cost drivers
Particulars A B C D
1) Machine development cost (480 x 8.02) (300 x 8.02) (160 x 8.02) (360 x 8.02)
= 3850 = 2,406 = 1,284 = 2,888
2) Setup Costs (6 x 250) (5 x 250) (4 x 250) (6 x 250)
= 1,500 = 1,250 = 1,000 = 1,500
3) Stores receiving (20 x 45) (20 x 45) (20 x 45) (20 x 45)
= 900 = 900 = 900 = 900
4) Inspection / quality control (6 x 100) (5 x 100) (4 x 100) (6 x 100)
= 600 = 500 = 400 = 600
5) Materials handling and dispatch (12 x 110) (10 x 110) (8 x 110) (12 x 110)
= 1,320 = 1,100 = 880 =1,320
Total overheads as per activity based
costing 8,170 6,156 4,464 7,208
Total overheads as per traditional methods 9,600 6,000 3,200 7,200
It will be seen that in this example there are significant differences between the costs using
the two systems. Product B and D costs is broadly the same but the costs of Product C are much
higher using ABC, whereas Product D is lower. ABC is more logical and precise than allocation of
overheads under traditional machine hour rate method
Illustration 3:
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

The budgeted overheads and cost driver volumes of XYZ Ltd. are as follows:
Cost pool Budgeted Cost driver Budgeted
Overhead volume
(Rs)
Material procurement 5,80,000 No. of orders 1,100
Material handling 2,50,000 No. of movements 680
Setup 4,15,000 No. of setups 520
Maintenance 9,70,000 Maintenance hours 8,400
Quality control 1,76,000 No. of inspections 900
Machinery overheads 7,20,000 No. of machine hours 24,000
The company has produced a batch of 2,600 components of AX-15, its material cost was Rs.
1,30,000 and labour cost was Rs. 2,45,000. The usage activities of the said batch are as follows:
Material orders 26 Maintenance hours 690
Material movements 18 Inspection 28
Setups 25 Machine hours 1,800
Required:
a. Calculate cost driver rates that are used for tracing appropriate amount of overheads
to the said batch.
b. Ascertain the cost of batch of components using ABC.
Solution

a. Calculation of Cost Driver Rates:

No Overheads Cost driver Cost driver per unit
1 Material procurement No of orders = Rs.5,80,000/1,100
= Rs. 527.27 per
order
2 Material handling No of = Rs. 2,50,000/680
movements = Rs. 367.64 per
movement

3 Setup No of Set up = Rs. 4,15,000/520

= Rs. 798.08 per set
up

4 Maintenance Maintenance = Rs. 9,70,000/8,400

hours = Rs. 115.48 per
maintenance hour

5 Quality control No of = Rs. 1,76,000/900

inspections = Rs. 195.56 per
inspection hour
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

6 Machine overheads No of machine =Rs.7,20,000/24,000

hours = Rs. 30 per machine
hour

b. Calculation Cost of a Batch of 2,600 Components of

AX-15
(Rs)
Direct material 1,30,000
Direct labour 2,45,000
Prime cost 3,75,000
Add: Overheads
Material procurement (26 x Rs. 527.27) 13,709
Material handling (18 x Rs. 367.64) 6,618
Setup cost (25 x Rs. 798.08) 19,952
Maintenance (690 x Rs. 115.48) 79,681
Quality control (28 x Rs. 195.56) 5,476
Machine (1,800 x Rs. 30) 54,000 1,79,436
Batch cost 5,54,436

Illustration 4:
The following details have been recorded for 4 batches made in a period
Batch A B C D
Output in units 250 60 200 120
Cost per batch
Direct material (Rs) 1,650 750 2,100 900
Direct labour (Rs) 9,200 1,520 6,880 2,400
Labour hours per batch 1,150 190 860 300

The total production overhead for the period has been analyzed as follows:
( Rs )
Machine related costs 14,600
Materials handling & dispatch 6,800
Stores 8,250
Inspection/Quality control 5,850
Setup 6,200
Engineering support 8,300
Total 50,000

Cost drivers have been identified for the cost pools as follows:
Cost pool Cost driver
Machine costs Machine hours
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Material handling Materials movements

Stores Requisitions raised
Inspection No. of inspections
Setup No. of setups
Engineering Engineering hours

The following cost driver volumes were recorded for the batches
Batch A B C D Total
Machine hours per batch 520 255 610 325 1,710
Material movements 180 70 205 40 495
Requisitions 40 21 43 26 130
Inspections 18 8 13 8 47
Setups 12 7 16 8 43
Engineering hours 65 38 52 35 190

Required:
a. The batch and unit costs using traditional costing based on a labour hour overhead
absorption rate
b. The batch and unit costs using ABC
c. Compare the costs in (a) and (b)
Solution
a. Allocation of overheads based on traditional method based on labour hours.
Rs. 50,000
Labour hour overhead absorption rate = 1,150 + 190 + 860 + 300 =Rs. 20 per hour

Allocation of overheads based on labour hour

A = (1,150 x 20) =23,000
B = (190 x 20) =3,800
C = (860 x 20) =17,200
D = (300 x 20) =6,000
50,000
b and c. Allocation of overheads based on Activity based costing
Calculation of Cost Driver Rates
Overheads Cost Driver Cost pool/ Cost Driver Rate
Total number of
cost driver
1.Machine cost Machine hours (Rs. 14,600/1,710) Rs. 8.54 per machine hour
2.Material Handling Material movements (Rs. 6,800/495) Rs. 13.74 per movement
3.Stores Requisition raised (Rs. 8,250/130) Rs. 63.46 per requisition
4.Inspection No of Inspection (Rs. 5,850/47) Rs. 124.47 per inspection
5.Set up No of Setups (Rs. 6,200/43) Rs. 144.19 per setup
6. Engineering Engineering hours (Rs. 8,300/190) Rs. 43.68 per hour

Allocation of overheads based on cost drivers

Batch A B C D
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Quantity 250 60 200 120

Machine hrs. @ Rs. 8.54 (520) 4,441 (255) 2,178 (610) 5,209 (325) 2,775
Movements @ Rs. 13.74 (180) 2,473 (70) 962 (205) 2,817 (40) 550
Requisitions @ Rs. 63.46 (40) 2,538 (21) 1,333 (43) 2,729 (26) 1,650
Inspections @ Rs. 124.47 (18) 2,240 (8) 996 (13) 1,618 (8) 996
Setups @ Rs. 144.19 (12) 1,730 (7) 1,009 (16) 2,307 (8) 1,154
Eng. hrs. @ Rs. 43.68 (65) 2,839 (38) 1,660 (52) 2,271 (35) 1,529
Total overheads (ABC) 16,261 8,138 16,951 8,654
Total overheads (traditional) 23,000 3,800 17,200 6,000

It will be seen that in this example there are significant differences between the costs using
the two systems. Batch C’s costs are broadly the same but the costs of Batch B and D are much
higher using ABC, whereas Batch A is lower. ABC is more logical and precise than allocation of
overheads under traditional machine hour rate method

Illustration 5 :
A B C D Co. Ltd. produces and sells four products A, B, C and D. These products are similar
and usually produced in production runs of 10 units and sold in a batch of 5 units. The production
details of these products are as follows:
Products A B C D
Production (units) 100 110 120 150
Cost per unit:
Direct material (Rs.) 30 40 35 45
Direct labour (Rs.) 25 30 30 40
Machine hour (per unit) 5 4 3 4

The production overheads during the period are as follows: (Rs.)

Factory works expense 22,500
Stores receiving costs 8,100
Machine setup costs 12,200
Cost relating to quality control 4,600
Material handling and dispatch 9,600
57,000

The cost drivers for these overheads are detailed below:

Cost Cost drivers
Factory works expenses Machine hours
Stores receiving costs Requisitions raised
Machine setup costs No. of production runs
Cost relating to quality control No. of production runs
Material handling and dispatch No. of orders executed
The number of requisitions raised on the stores was 25 for each product and number of
orders executed was 96, each order was in a batch of 5 units.
Required –
i. Total cost of each product assuming the absorption of overhead on machine hour basis.
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

ii. Total cost of each product assuming the absorption of overhead by using activity base
costing, and
iii. Show the differences between (i) and (ii) and comment.
Solution
a. Allocation of overheads based on traditional method based on machine hours.
Total Machine Hours
= (100 x 5) + (110 x 4) + (120 x 3) + (150 x 4)
= 500 + 440 + 360 + 600 = 1,900
Production overhead per machine hour
= Total Overhead/ no of machine hours
= Rs. 57,000/1,900 = Rs. 30
A = (500 x 30) = 15,000
B = (440 x 30) = 13,200
C = (360 x 30) = 10,800
D = (600 x 30) = 18,000
57,000
b. Allocation of overheads using Activity based costing
Computation of total cost of each product assuming the absorption of overhead by using
Activity Based Costing
Factory works expenses 22,500
(a) Factory Works Expense = Machines Hours = Rs. l,900
= Rs. 11.84
( Machine hours)

Stores receiving costs Rs. 8,100

(b) Stores Receiving Costs= Requisition raised = 100 (25 × 4) = Rs 81
(No Requisitions raised)
Machine setup costs Rs. 12,200
(c) Machine Setup Cost= No of production runs = 48 = Rs254.17

(No. of production runs)

Quality control costs Rs. 4,600
(d) Cost relating to Quality Control = No of production runs = 48
=Rs. 95.83
(No. of production runs)
Material handling and dispatch costs
(e) Material Handling and Dispatch = No of orders executed
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Rs. 9,600
= 96 = Rs 100

(No. of orders executed)

Statement Showing Computation of Total Cost of each Product under ABC
WN: No. of Production
A = (100 / 10) = 10
B = (110 / 10) = 11
C = (120 / 10) = 12
D = (150 / 10) = 15
48
WN: No. of requisition
A = (100 / 5) = 20
B = (110 / 5) = 22
C = (120 / 5) = 24
D = (150 / 5) = 30
96
Allocation of overheads based on cost drivers
Batch A B C D
Factory Expenses 5,920 5,210 4,262 7,104
(500 x 11.84) (440 x 11.84) (360x 11.84) (600 x 11.84)
Stores receiving cost 2,025 2,025 2,025 2,025
(25x 81) (25x 81) (25x 81) (25x 81)
Machine set up cost 2,542 2,796 3.050 3,813
(10 x 254.17) (11 x 254.17) (12 x 254.17) (15 x 254.17)
Cost relating to quality control 958 1,054 1,150 1,438
(10 x 95.83) (11 x 95.83) (12 x 95.83) (15 x 95.83)
Material handling Dispatch 2,000 2,200 2,400 3,000
(20 x 100) (22 x 100) (24 x 100) (30 x 100)
Total cost as per ABC 13,445 13,285 12,887 17,380
Total cost as per Traditional method 15,000 13,200 10,800 18,000

It will be seen that in this example there are significant differences between the costs using
the two systems. Product B costs are broadly the same but the costs of Product C are much higher
using ABC, whereas A and D is lower. ABC is more logical and precise than allocation of overheads
under traditional machine hour rate method
Illustration 6 :
XYZ Ltd. manufactures four products, namely A, B, C and D using the same plant and
process. The following information relates to a production period:
Product A B C D
Output (units) 720 600 480 504
Cost per unit:
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Direct Material (Rs.) 42 45 40 48

Direct labour (Rs.) 10 9 7 8
Machine hours per unit 4 hrs. 3 hrs. 2 hrs. 1 hr.

The four products are similar and are usually produced in production runs of 24 units and
sold in batches of 12 units. Using machine hour rate currently absorbs the production overheads.
The total overheads incurred by the company for the period is as follows:
(Rs.)
Machine operation and maintenance cost 63,000
Setup costs 20,000
Store receiving 15,000
Inspection 10,000
Material handling and dispatch 2,592
During the period the following cost divers are to be used for the overhead cost:
Cost Cost driver
Setup cost No. of production runs
Store receiving Requisition raised
Inspection No. of production runs
Material handling and dispatch Orders executed
It is also determined that:
 Machine operation and maintenance cost should be apportioned between setup cost,
store receiving and inspection activity in 4 : 3 : 2.
 Number of requisitions raised on store is 50 for each product and the number of orders
executed is 192, each order being for a batch of 12 of a product.
Required:
i. Calculate the total cost of each product, if all overhead costs are absorbed on machine
hour rate basis.
ii. Calculate the total cost of each product using activity base costing.
iii. Comment briefly on differences disclosed between overheads traced by present system
and those traced by activity base costing.
Solution
a. Allocation of overheads based on Machine hour
Total Machine Hours requirement
Product A (720 units x 4 hrs.) 2,880
Product B (600 units x 3 hrs.) 1,800
Product C (480 units x 2 hrs.) 960
Product D (504 units x 1 hrs.) 504
Total machine hours required 6,144

(Rs.)
Machine operation and maintenance cost 63,000
Setup costs 20,000
Store receiving 15,000
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

Inspection 10,000
Material handling and dispatch __2,592
Total overheads 1,10,592

Machine hour rate of absorption of overheads = Rs. 1,10,592 / 6,144 = Rs. 18 per machine
hour

Product A (2880 x 18) = Rs 51,840

Product B (1800 x 18) = Rs 32,400
Product C (960 x 18) = Rs 17,280
Product D (504 x 18) = Rs 9072
Rs 1,10,592

b. Calculation or of total cost of each product under Activity Base Costing

Machine operation and maintenance cost Rs. 63,000 to be apportioned between setup cost,
store receiving and inspection activity in 4 : 3 : 2.
Setup = Rs. 63,000 x 4/9 = Rs. 28,000
Store receiving = Rs. 63,000 x 3/9 = Rs. 21,000
Inspection = Rs. 63,000 x 2/9 = Rs. 14,000
Cost Rs. Cost Driver No. Cost per unit of
driver (Rs.)
Setup cost 48,000 No. of production runs 96 48000/96=500
Store receiving 36,000 Requisition raised 200 36,000/200=180
Inspection 24,000 No. of productions runs 96 24,000/ 96=250
Material handling and 2,592 Ordered executed 192 2,592/192 =13.50
dispatch
WN: Number of Production Runs
Product A = 720 units/24 = 30 Product C = 480 units/24 = 20
Product B = 600 units/24 = 25 product D = 504 units/24 = 21
WN: Number of orders Executed
Product A = 720 units/12 = 60 Product C = 480 units/12 = 40
Product B = 600 units/12 = 50 Product D = 504 units/12 = 42
Allocation of overheads based on cost drivers
Product A B C D

Set up Cost 15,000 12,500 10,000 10,500

(30 x 500) (25 x 500) (20 x 500) (21 x 500)
Stores receiving 9,000 9,000 9,000 9,000
(50 x 180) (50 x 180) (50 x 180) (50 x 180)
Inspection 7,500 6,250 5,000 5,250
(30 x 250) (25x 250) (20 x 250) (21 x 250)
Material handling and dispatch 810 675 540 567
(60 x 13.50) (50 x 13.50) (40 x 13.50) (42 x 13.50)
Total overheads as per ABC 32,310 28,425 24,540 25,317
Total overheads as per 51,840 32,400 17,280 9,072
Traditional method
 CA.CS.CMA.MBA: Naveen. Rohatgi Cost Accounting for Engineers

It will be seen that in this example there are significant differences between the costs using
the two systems. Costs of Product C and D are much higher using ABC, whereas Product A and
B is lower. ABC is more logical and precise than allocation of overheads under traditional machine
hour rate method
The total overheads are apportioned to the four products on a single base i.e. machine hours
under traditional system of absorption costing. But in activity based system the apportionment
of each item of overhead cost is on a scientific basis, depends on the consumption or use of
different services or cost drivers which lead the cost to be incurred. The unit cost of each product
ascertained under activity based cost system is more appropriate and relevant for decision
making rather than absorption of overheads under traditional system.