Application Of Activity Based Costing Methods In Manufacturing

Significance of Two Costing Methods

Discuss about the Application Of Activity Based Costing Methods.

The Happy Traveller limited is a manufacturing company which manufactures two types of luggage such as ‘simple luggage’ and ‘complex luggage’. The purpose of this report is to perform traditional costing approach and Activity based costing approach in Happy traveller limited. The report further explains the significance of both costing approaches. The costs per unit of both products from both approaches are computed and on the basis of costs per unit comparison will be performed. Benefits and costs in adopting ABC approach in Happy traveller limited is analysed.

Traditional costing approach assigns cost on the basis of single or average overhead rate. In other words, all the overhead costs applied equally to all the products by using one cost driver normally machine hours (Eldenburg and Wolcott, 2009). It is reasonable to implement. It is also very easy to use and simple to understand by the outsiders.
Activity Based Costing approach assigns indirect expenses (manufacturing overhead) to the products based on its consumption of each activity. In other words, all the overhead costs applied to the products by using multiple cost drivers. This approach is very expensive to implement but the results are more accurate. This method is very useful for manufacturing companies having high overhead costs (Helmi, 2015).

Allocation of manufacturing overhead costs as per simple costing system
Production centres	machine centre A, machine centre B and Assembly centre Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Service centres	materials procurement and general factory support
Particulars	Machine centre A	Machine centre B	Assembly centre	materials procurement	general factory support
Indirect wages and supervision	$ 14,61,538.46	$ 8,76,923.08	$ 14,61,538.46	$ 21,00,000.00	$ 18,80,000.00
Total costs = $ 3800000
total hours = 5200000
Indirect materials	$ 6,50,000.00	$ 4,87,500.00	$ 1,62,500.00	$ –	$ 20,000.00
Total costs = $ 1300000
material issued = $ 4000000, $ 3000000 and $ 1000000 for Machine centre A, B and assembly centre respectively
Lighting and heating	$ 95,192.31	$ 84,615.38	$ 1,26,923.08	$ 1,58,653.85	$ 84,615.38
Total costs = $ 550000
Area occupied = 52000 square metre
property taxes	$ 1,47,115.38	$ 1,30,769.23	$ 1,96,153.85	$ 2,45,192.31	$ 1,30,769.23
Total costs = $ 850000
Area occupied = 52000 square metre
insurance of machinery	$ 1,31,578.95	$ 90,460.53	$ 13,157.89	$ 6,578.95	$ 8,223.68
Total costs = $ 250000
BV of machinery = $ 15200000
Depreciation of machinery	$ 8,42,105.26	$ 5,78,947.37	$ 84,210.53	$ 42,105.26	$ 52,631.58
Total costs = $ 1600000
BV of machinery = $ 15200000
Insurance of buildings	$ 51,923.08	$ 46,153.85	$ 69,230.77	$ 86,538.46	$ 46,153.85
Total costs = $ 300000
Area occupied = 52000 square metre
Salaries of works management	$ 3,40,000.00	$ 2,10,000.00	$ 3,50,000.00	$ 1,00,000.00	$ 1,00,000.00
Total costs = $ 1100000
Number of employees = 1100 employees
TOTAL MANUFACTURING OVERHEAD COSTS	$ 37,19,453.44	$ 25,05,369.43	$ 24,63,714.57	$ 27,39,068.83	$ 23,22,393.72
Further costs of two service centres (materials procurement and general factory support) will further allocated to three production centre costs (machine centre A, machine centre B and Assembly centre). The basis of allocation of costs are as follows:
Materials procurement costs:	Allocation based on value of materials issued
Materials procurement costs:	$ 27,39,068.83
details of Total value of materials issued are:
Machine centre A	$ 40,00,000.00
Machine centre B	$ 30,00,000.00
Assembly centre	$ 10,00,000.00
Total	$ 80,00,000.00
Allocated material procurement costs to production centres are:
Machine centre A	$ 13,69,534.41
Machine centre B	$ 10,27,150.81
Assembly centre	$ 3,42,383.60
General factory support costs:	Allocation based on direct labour hours
General factory support costs:	$ 23,22,393.72
details of Total direct labour hours are:
Machine centre A	900000
Machine centre B	1000000
Assembly centre	2000000
Total	3900000
Allocated general factory costs to production centres are:
Machine centre A	$ 5,35,937.01
Machine centre B	$ 5,95,485.57
Assembly centre	$ 11,90,971.14
Therefore total revised production centres costs are:
Machine centre A	$ 56,24,924.87
Machine centre B	$ 41,28,005.81
Assembly centre	$ 39,97,069.32
TOTAL PRODUCTION CENTRES COSTS	$ 137,50,000.00
Total costs allocated to two products are as follows:
particulars	Simple luggage	complex luggage
Direct Costs	$ 80.00	$ 200.00
Manufacturing overhead costs	$ 63.46	$ 132.21
Total costs per unit	$ 143.46	$ 332.21
W note no. 1
Calculation of number of units
Simple luggage
1 batch	100 units
1 unit:
machine centre A (hrs)	4
machine centre B (hrs)	10
Assembly centre (hrs)	10
Total hours per unit	24
Total hours:
machine centre A	2000000
machine centre B	1200000
Assembly centre	2000000
Total hours	5200000
Formula:
number of units = Total hours / hours per unit
number of batches = total units / unit per batch

total Units	216667
total Batches	2167
Complex luggage
1 batch	200 units
1 unit:
machine centre A (hrs)	10
machine centre B (hrs)	20
Assembly centre (hrs)	20
Total hours per unit	50
Total hours:
machine centre A	2000000
machine centre B	1200000
Assembly centre	2000000
Total hours	5200000
Formula:
number of units = Total hours / hours per unit
number of batches = total units / unit per batch
total Units	104000
total Batches	520

Allocation of manufacturing overhead costs as per Activity based costing system
The totals costs are as follows:
Particulars	Amount ($)
Machine Centre A (from tab traditional costing system)	$ 37,19,453.44
Machine Centre B (from tab traditional costing system)	$ 25,05,369.43
Assembly Centre (from tab traditional costing system)	$ 24,63,714.57
Material Procurement costs
Purchasing Materials (given in question)	$ 10,95,628.00
Receiving Materials (given in question)	$ 5,40,123.00
Disburse materials (given in question)	$ 11,03,318.00
general factory support costs
Production Scheduling (given in question)	$ 12,77,317.00
Set up machines (given in question)	$ 6,20,300.00
Quality Inspection (given in question)	$ 4,24,777.00
Total manufacturing overhead costs	$ 137,50,000.45
Allocation of costs to two products are as follows:
Cost per unit
particulars	Simple luggage	complex luggage
Direct Costs	$ 80.00	$ 200.00
Manufacturing overhead costs:
Machine Centre A costs (refer 1)	$ 7.44	$ 18.60
Machine Centre B costs (refer 2)	$ 20.88	$ 41.76
Assembly centre costs (refer 3)	$ 12.32	$ 24.64
Material Procurement costs
1. Purchasing materials costs (refer 4)	$ 1.14	$ 0.57
2. Receiving materials costs (refer 5)	$ 1.08	$ 0.54
3. Disburse materials costs (refer 6)	$ 27.58	$ 2.76
general factory support costs
1. Production scheduling costs (refer 7)	$ 31.93	$ 3.19
2. Set up machine costs (refer 8)	$ 25.85	$ 2.58
3. Quality inspection costs (refer 9)	$ 4.25	$ 2.12
Total costs per unit	$ 212.47	$ 296.76
Calculation of Activity rate
Cost pool	Cost ($) [A]	Cost driver [B]
Purchasing Materials (given in question)	$ 10,95,628.00	purchase orders (9600)
Receiving Materials (given in question)	$ 5,40,123.00	receipts (5000)
Disburse materials (given in question)	$ 11,03,318.00	production runs (2000)
Production Scheduling (given in question)	$ 12,77,317.00	production runs (2000)
Set up machines (given in question)	$ 6,20,300.00	Set up hours (12000)
Quality Inspection (given in question)	$ 4,24,777.00	inspections (1000)
TOTAL	$ 50,61,463.00
W note no. 1
Given that :
Machine Centre A costs
Particulars	Simple luggage	Complex luggage
Machine Centre A costs	$ 37,19,453.44	$ 37,19,453.44
total machine centre A hours	2000000	2000000
Cost per hour	$ 1.86	$ 1.86
Hours per unit	4	10
Cost per unit	$ 7.44	$ 18.60
W note no. 2
Given that :
Machine Centre B costs
Particulars	Simple luggage	Complex luggage
Machine Centre B costs	$ 25,05,369.43	$ 25,05,369.43
total machine centre B hours	1200000	1200000
Cost per hour	$ 2.09	$ 2.09
Hours per unit	10	20
Cost per unit	$ 20.88	$ 41.76
W note no. 3
Given that :
Assembly centre costs
Particulars	Simple luggage	Complex luggage
Assembly centre costs	$ 24,63,714.57	$ 24,63,714.57
total assembly hours	2000000	2000000
Cost per hour	$ 1.23	$ 1.23
Hours per unit	10	20
Cost per unit	$ 12.32	$ 24.64
W note no. 4
Given that :
Purchasing materials costs
Particulars	Simple luggage	Complex luggage
Purchasing materials costs	$ 10,95,628.00	$ 10,95,628.00
purchase orders	9600	9600
cost per order	$ 114.13	$ 114.13
units per batch	100	200
orders per batch	1	1
units per order	100	200
Cost per unit [cost per order/units per order]	$ 1.14	$ 0.57
W note no. 5
Given that :
Receiving materials costs
Particulars	Simple luggage	Complex luggage
Receiving materials costs	$ 5,40,123.00	$ 5,40,123.00
material receipts	5000	5000
cost per receipt	$ 108.02	$ 108.02
units per batch	100	200
receipts per batch	1	1
units per receipt	100	200
Cost per unit [cost per receipt/units per receipt]	$ 1.08	$ 0.54
W note no. 6
Given that :
Disburse materials costs
Particulars	Simple luggage	Complex luggage
Disburse materials costs	$ 11,03,318.00	$ 11,03,318.00
Production runs	2000	2000
cost per production run	$ 551.66	$ 551.66
units per batch	100	200
production run per batch	5	1
units per production run	20	200
Cost per unit	$ 27.58	$ 2.76
W note no. 7
Given that :
Production scheduling costs
Particulars	Simple luggage	Complex luggage
Production scheduling costs	$ 12,77,317.00	$ 12,77,317.00
Production runs	2000	2000
cost per production run	$ 638.66	$ 638.66
units per batch	100	200
production run per batch	5	1
units per production run	20	200
Cost per unit	$ 31.93	$ 3.19
W note no. 8
Given that :
Set up machines costs
Particulars	Simple luggage	Complex luggage
Set up machine costs (refer 8)	$ 6,20,300.00	$ 6,20,300.00
Set up hours	12000	12000
Cost per set up hour	$ 51.69	$ 51.69
units per batch	100	200
set up hours per batch	50	10
units per set up hours	2	20
Cost per unit	$ 25.85	$ 2.58
W note no. 9
Given that :
Quality inspection costs
Particulars	Simple luggage	Complex luggage
Quality inspection costs	$ 4,24,777.00	$ 4,24,777.00
inspections	1000	1000
cost per inspection	$ 424.78	$ 424.78
units per batch	100	200
inspection per batch	1	1
units per inspection	100	200
Cost per unit [cost per inspection/units per inspection]	$ 4.25	$ 2.12

Costs per unit in Traditional costing system

Particulars	Simple luggage	complex luggage
Direct Costs	$ 80.00	$ 200.00
Manufacturing overhead costs	$ 63.46	$ 132.21
Total costs per unit	$ 143.46	$ 332.21

Costs per unit in ABC costing system

Particulars	Simple luggage	complex luggage
Direct Costs	$ 80.00	$ 200.00
Manufacturing overhead costs:
Machine Centre A costs (refer 1)	$ 7.44	$ 18.60
Machine Centre B costs (refer 2)	$ 20.88	$ 41.76
Assembly centre costs (refer 3)	$ 12.32	$ 24.64
Material Procurement costs:
1. Purchasing materials costs (refer 4)	$ 1.14	$ 0.57
2. Receiving materials costs (refer 5)	$ 1.08	$ 0.54
3. Disburse materials costs (refer 6)	$ 27.58	$ 2.76
general factory support costs:
1. Production scheduling costs (refer 7)	$ 31.93	$ 3.19
2. Set up machine costs (refer 8)	$ 25.85	$ 2.58
3. Quality inspection costs (refer 9)	$ 4.25	$ 2.12
Total costs per unit	$ 212.47	$ 296.76

From the above results of cost per unit, it has been observed that costs per unit of Simple luggage increases from $ 143.46 to $ 212.47 whereas the costs per unit of Complex luggage decreases from $ 332.21 to $ 296.76. This is because in traditional costing system, costs are allocated applied equally to all the products by using one cost driver rate normally machine hours and in ABC costing system, all the indirect costs or expenses are allocated with multiple cost drivers (Ozyurek and Uluturk, 2015). Hence, considering this question, activity cost drivers are no. of production runs, no. of set-up hours, no. of inspections, no. of purchase orders and no. of material receipts. In simple luggage type, there was a batch of 100 units and so the ABC costing is not beneficial to this type of luggage whereas in complex luggage type, there was a batch of 200 units and so the ABC costing is beneficial to this type of luggage because it allocates costs as per the consumption of activity.

COSTS

BENEFITS

· It is very expensive to implement the ABC system.

· The installation of ABC system is also time consuming.

· It can be irrelevant in certain decisions such as it is not useful for external reporting (Hurlburt and Kirshstein, 2014).

· It does not take into account accounting standards.

· It is not useful for small business enterprises.

· It Is a refined process of allocating indirect costs to different products as per activity cost drivers. In other words, it determines the true cost of the product (Eldenburg and Wolcott, 2009).

· The usage of this costing system helps in identifying which process is performing well and which produces more returns.

· It also identifies non valued resources within the company which further improves business processes and decision making (Hurlburt and Kirshstein, 2014).

· Cost drivers can be used advantageously that are likely to be allocated to the product.

Better estimations and projections are offered by ABC system which helps in identifying wasteful resources and improves business processes. Further it helps in identifying time and labour costs spent on any activity. In simple words, accurate results were found which helps in taking decisions better (Helmi, 2015).

Thus, as a result it can be said that Implementation of ABC system produces long term returns to the company. Hence, Happy traveller limited must adopt ABC system.

References

Eldenburg, L.G. and Wolcott, S.K. 2009, Cost management: measuring, monitoring and motivating performance, John wiley and sons.

Helmi, J. 2015, ‘The Activity-Based costing (ABC) in the institutions of higher education (IHE): Do private and public bring a different?’, Asian Journal of basic and applied sciences, vol.2, no.1, 16-30.

Hurlburt, S. and Kirshstein, R 2014, The ABCs of Activity Based costing in community colleges, American institutes for research.

Ozyurek, H and Uluturk, Y 2015, ‘Application of activity based costing methods given strategic decisions in private education’, European Journal of accounting Auditing and finance research, vol.3, no.4, pp.1-14.

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