1. ACTIVITY BASED COSTING
CONCEPT: IN ORDER TO UNDERSTAND THE CONCEPT OF ACTIVITY BASED COSTING, WE
SHOULD KNOW THE TRADITIONAL OR CONVENTIONAL APPROACH OF ASSIGNING
OVERHEAD COST.
TRADITIONAL APPROACH:
 TRADITIONALLY MANUFACTURING COMPANIES USE MEASURES OF PRODUCTION
VOLUME (COST DRIVER, LIKE DIRECT LABOR HOURS, DIRECT LABOR COST,
MACHINE HOURS etc) AS BASIS OF ALLOCATION.
FOR EXAMPLE:
SUPPOSE A COMPANY MAKES TWO PRODUCTS A and B AND BELIEVES THAT
MACHINE HOURS DRIVE OVERHEAD COST. DATA ARE
A B TOTAL
MACHINE HORS PER UNIT 2 4
TOTAL UNITS 100,000 25,000
TOTAL HOURS 200,000 100,000 300,000
TOTAL OVERHEAD COST 900,000
REQUIRED: ALLOCATE OVERHEAD COST TO PRODUCT A and B.
 THE PROBLEM WITH THE TRADITIONAL APPROACH IS THAT IT ASSUMES ALL
OVERHEAD COST ARE PROPORTIONAL TO PRODUCTION VOLUME i.e WHEN
PRODUCTION VOLUME INCREASED BY 20%, OVERHEAD INCREASED BY 20%. BUT
THERE ARE MANY OVERHEAD COST LIKE MACHINE SETUP COST ,COST OF
HANDLING AND INSPECTING MATERIAL ,ARE NOT PROPORTIONAL TO VOLUME
,THUS HIGH VOLUME PRODUCTS ARE OFTEN HIGH COSTED AND LOW VOLUME
PRODUCT ARE UNDER COSTED.
 ACCOUNTANTS TODAY RECOGNIZES TWO OTHER MAJOR INFLUENCE ON COST
COMPLEXITY AND DIVERSITY OF OPERATION.
 AS COMPANY’S PRODUCTS BECOMES MORE COMPLICATED, HAVING MORE PARTS
AND REQUIRING MORE OPERATIONS COST WILL INCREASE EVEN THOUGH TOTAL
OUTPUT DOES NOT, SIMILARLY IF COMPANY INCREASES THE VARIETY OF ITS
PRODUCT OFFERINGS, COST WILL INCREASE EVEN IF TOTAL OUTPUT REMAINS
CONSTANT.
 IN A BUSINESS CONTEXT IMAGINE TWO MANUFACTURERS OF BRICKS, UNI BRICK
AND MULTI BRICK. BOTH COMPANIES MAKES 10,000,000 BRICKS. BUT UNI BRICKS
MAKES RED BRICKS OF A SINGLE SIZE ,SHAPE AND TEXTURE AND SELL IT TO FEW
CUSTOMERS WHEREAS MULTI BRICKS MAKES 10,000,000 BRICKS BUT IN DOZEN
COLORS FOUR FIXTURES AND EIGHT SIZE AND SHAPE I.E (12*4*8) POSSIBILITIES.

2.  EVEN THOUGH BOTH COMPANIES HAVE THE SAME SALES AND PRODUCTION
VOLUMES BUT MULTI BRICKS TOTAL COST WILL EXCEED UNI BRICKS BECAUSE
SO MANY MULTI BRICKS COST WILL BE DRIVEN BY ACTIVITIES OTHER THAN
VOLUME, LIKE THE NUMBER OF SETUPS , PRODUCTION ORDERS ,SALES ORDERS,
OF COURSE, DESPITE ITS HIGHER COST .
 ABC COSTING DEVELOPED AS MANAGERS UNDERSTOOD THAT LOW VOLUME
PRODUCTS COULD BE LESS PROFITABLE THAN APPEARED AND HIGH VOLUME
PRODUCT COULD BE MORE PROFITABLE THAN APPEARED .
EXAMPLE:
ASSUME MULTI BRICKS MAKES THREE TYPE OF BRICKS MODEL A-42 , MODEL A-88 AND
MODEL C-11. MODEL A-88 AND A-42 ARE LOW VOLUME SPECIALTY BRICKS WHILE
MODEL C-11 IS A HIGH VOLUME BRICK AND DOES NOT REQUIRE SPECIAL INGREDIENT
OR SPECIAL HANDLING. MULTI BRICK MAKES MODEL A-42 AND A-88 IN SHORT
PRODUCTION RUNS AND EACH REQUIRES SPECIAL INGREDIENT, DIFFERENT OVEN
TEMPERATURE, SETTINGS AND SPECIAL HAND MOLDING.
DATA:
TOTAL MANUFACTURING OVERHEADS: RS 800,000
TOTAL OUTPUT: 10,000,000 BRICKS
MODEL A-42 MODEL-A88 MODEL-C11
TOTAL PRODUCTION 6,000 4,000 100,000
MATERIAL COST PER BRICK RS 0.05 RS 0.04 RS 0.03
DIRECT LABOR COST PER BRICK RS 0.06 RS 0.07 RS 0.04
ASSUME OVERHEAD IS ALLOCATED ON THE BASIS OF UNITS PRODUCED CALCULATE
TOTAL UNIT COST AND TOTAL COST OF EACH MODEL.

3. ASSUME THE COMPANY HAS CHANGE ITS POLICY FROM TRADITIONAL TO ABC
APPROACH AND FOR THIS HAVE IDENTIFIED THREE MAJOR RESOURCE DRIVERS I.E
BAKING BRICKS , SETUPS TO CHANGE FROM ONE MODEL TO ANOTHER AND
PRODUCTION ORDERS
DATA
RESOURCE DRIVER COST IN POOL TOTAL AMOUNT OF DRIVER
SETUPS RS 120,000 10,000
BAKING TIME RS 600,000 300,000 HOURS
CUSTOMER ORDERS RS 80,000 5,000 ORDERS
TOTAL RS 800,000
ACTIVITY DATA
MODEL-A 42 MODEL-A88 MODELC-11
NUMBER OF SETUPS 150 180 30
BAKING TIME 60 50 300
NUMBER OF CUSTOMER ORDERS 30 40 20
ASSUME THE SAME COST OF MATERIAL AND LABOR , CALCULATE THE TOTAL COST PER
UNIT AND TOTAL COST USING ACTIVITY APPROACH , AND COMPARE IT WITH
TRADITIONAL APPROACH.