This document provides information on activity-based costing (ABC), including: - The key concepts of ABC including cost objects, activities, cost pools, and cost drivers. - The steps involved in the ABC process, such as identifying activities, calculating activity costs, determining cost drivers, and assigning costs to products. - An example problem demonstrating the calculation of product costs per unit using both traditional costing and ABC. - The benefits of ABC including a focus on cost behaviors and value-added activities to provide better cost information for pricing and profitability decisions.

1. M. C. Sharma
Associate Professor
Department of Commerce
Shaheed Bhagat Singh Evening College
(University of Delhi)
Delhi
Updated on 29/03/2020
1

2. 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
2

3. 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 percentage on direct
material/direct labour or prime cost,
 Labour hour rate or machine hour rate.
3

4. Concept of 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 centers. 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.
4

5. 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.
5

6. 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 hours.
 For production activity: machine hours or labour
hours.
 For repairs and maintenance activity: Number of
service calls, time spent in repairs and maintenance.
6

7. 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:
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
7

8. 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
8

9. 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.
9

10. DU B. Com. (H) 2006 &2013
A Company manufacturing two products furnishes the following data for a year:
The annual overheads are as under:
 Volume related activity cost Rs. 5,50,000
 Setup related cost Rs. 8,20,000
 Purchase order related cost Rs. 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.
10
Products annual output
(units)
total machine
hours
total number of
purchase orders
total number of
set-ups
A 5,000 20,000 160 20
B 60,000 1,20,000 384 44

11.  Solution:
Total Overheads = Rs. 5,50,000 + Rs. 8,20,000 + Rs.
6,18,000 = Rs. 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
Machine Hour Rate (General) =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠
=
19,88,000
1,40,000
= Rs. 14.20 per hour
11

12.  Solution:
Total Overheads = Rs. 5,50,000 + Rs. 8,20,000 + Rs. 6,18,000 = Rs. 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
Machine Hour Rate (General) =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠
=
19,88,000
1,40,000
=
Rs. 14.20 per hour
2. Activity Based Costing
(a) For Volume related Costs, Machine Hour Rate
=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑣𝑜𝑙𝑢𝑚𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠
=
5,50,000
1,40,000
= Rs. 3.93 per hour
(b) For set-up related Costs, Set-up Rate
=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑠𝑒𝑡−𝑢𝑝 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑒𝑡−𝑢𝑝𝑠
=
8,20,000
64
=
Rs. 12,850.50 per set-up
12

13. (c) For purchase related Costs, Overheads per purchase order
=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑟𝑑𝑒𝑟𝑠
=
6,18,000
544
= Rs. 1,136.03 per order
A) Statement of Overhead Cost Per Unit (Traditional Method)
13
Products Annual
Output
Total machine
Hours
Overhead Costs Overhead Cost
per unit
A 5,000 20,000 20,000 x 14.20
= 2,84,000
2,84,000/5,000
= 56.80
B 60,000 1,20,000 1,20,000 x 14.20
= 17,04,000
17,04,000/60,000
= 28.40

14. B) Statement of Overhead Cost Per Unit (Activity Based Costing Method)
14
Product and
Annual Output
Overheads Costs Overhead cost
per unit
A (5,000 units) Cost related to Volume
activities
20,000 x 3.93
= 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
activities
1,20,000 x 3.93
= 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

15. 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:
 Machine activity expenses Rs. 3,00,000
 Setup related expenses Rs. 30,000
 Expenses related to orders Rs. 35,000
Calculate the overheads per unit absorbed using activity based costing
approach.
15
Product Units
produced
Direct
Labour
Hours per
unit
Machine
Hours per
unit
Set-ups of
machines
Orders
A 1,000 2 6 15 18
B 2,000 3 1.5 50 70

16. DU B. Com. (H) 2012 – Detailed Answer
(a) For machine related Costs, Machine Hour Rate
=
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠
=
3,00,000
9,000
= Rs. 33.33 per hour
(b) For set-up related Costs, Set-up Rate
=
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑠𝑒𝑡−𝑢𝑝 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑒𝑡−𝑢𝑝𝑠
=
30,000
65
= Rs. 461.54 per set-up
(c) For order related Costs, Overheads per order
=
𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑜𝑟𝑑𝑒𝑟 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠
=
35,000
88
= Rs. 397.73 per order
(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)
16

17. 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 – Rs. 25 and Product B – Rs. 15
 Direct labour @ Rs. 5 per hour : Product A – Rs. 10 and Product B – Rs. 10
The company's total manufacturing overhead costs are Rs. 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:
17

18. 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:
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.
18
Activity Traceable
costs (Rs.)
Number of events or transactions
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

19. DU B. Com. (H) 2011 – Detailed Answer
(1) Computation of product cost using direct labour hour rate
=
𝑇𝑜𝑡𝑎𝑙 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑇𝑜𝑡𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑢𝑟 𝐻𝑜𝑢𝑟𝑠
=
8,75,000
50,000
= Rs. 17.50 per hour
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 = Rs. 46
(ii) Cost per inspection = Rs. 20
(iii) Cost per production order = Rs. 135
(iv) Cost per machine hour worked = Rs. 7.85
(v) Cost per material receipt = Rs. 120
Overhead cost per Unit = Product A – Rs. 75.44 and Product B – Rs. 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 24.89)
19

20. THANKS
Please inform
your feedback, doubts and suggestions to me.
Email: m_c_Sharma@yahoo.com
20