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Activity Based Costing as a measure of improving the cost structure at SAI

PACKING LTD, MYSORE

INDEX
Sr.No.

CONTENTS

Executive summary

Industry Profile

Organization profile

Research Methodology

Data Collection

Conceptual Framework

Analysis

Findings

Suggestions

10

Conclusion

11

Bibliography

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Activity Based Costing as a measure of improving the cost structure at SAI


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EXECUTIVE SUMMARY

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

EXECUTIVE SUMMARY

A study report on ACTIVITY BASED COSTING AS A MEASURE OF


IMPROVING THE COST STRUCTURE OF SAI PACKING LTD,MYSORE,
a project undertaken at SAI PACKING LTD,MYSORE.

Activity-Based Costing (ABC) represents an alternative paradigm to traditional cost


accounting system and it often provides more accurate cost information for decision
making such as product pricing, product mix, and make-or buy decisions. ABC
models the causal relationships between products and the resources used in their
production and traces the cost of products according to the activities through the use
of appropriate cost drivers.

In this project, the costing system followed by SAI PACKING


LTD,MYSORE is compared with ABC in terms of the effects on the product costs
that are carried out to highlight the difference between two costing methodologies.
By using this methodology, a valuable insight into the factors that cause the cost is
provided, helping to better manage the activities of the company.

According to the study, SAI PACKING LTD,MYSORE follows


traditional method for costing that assigns overheads directly to the product. Cost of
the product UC Range series 4 end cover is found out by Activity Based costing and
is compared with the traditional method followed by SAI PACKING
LTD,MYSORE to arrive at the cost of the above product. The study states that the
product is being over cost by the company.

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

SAI PACKING LTD,MYSORE should go for Activity Based costing as


it understands true profitability of the customers, products, or services and also helps
in identifying areas where the cost can be reduced or efficiencies can be increased.

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

INDUSTRY PROFILE

Activity Based Costing as a measure of improving the cost structure at SAI


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INDUSTRY PROFILE
Manufacturing Industry

Manufacturing industry refers to those industries which involve in the


manufacturing and processing of items and indulge in either creation of new
commodities or in value addition. The manufacturing industry accounts for a
significant share of the industrial sector in developed countries. The final products
can either serve as a finished good for sale to customers or as intermediate goods
used in the production process.

Manufacturing industries are the chief wealth producing sectors of an economy.


These industries use various technologies and methods widely known as
manufacturing

process

management.

Manufacturing

industries

are

broadly

categorized into engineering industries, construction industries, electronics industries,


chemical industries, energy industries, textile industries, food and beverage
industries,

metalworking

industries,

plastic

industries,

etc.

Manufacturing industries are important for an economy as they employ a huge share
of the labor force and produce materials required by sectors of strategic importance
such as national infrastructure and defense. However, not all manufacturing industries
are beneficial to the nation as some of them generate negative externalities with huge
social costs. The cost of letting such industries flourish may even exceed the benefits
generated by them.
Indias manufacturing base, which is the fourth-largest among emerging economies,
is among the fastest growing and has seen more investments as a proportion of gross
domestic product than any country except China. Employment opportunities in the
manufacturing industry have declined comparatively. Manufacturing industry
analysis also suggests that in some countries like China, technological know how has

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

to be developed. Despite the fact that China is ranked fourth in the manufacturing
productivity, due to technological lacunae, it is not being able to compete in the world
market. Also needed are professionals well versed in the technological know how.
The Government has taken several initiatives to accelerate growth in this sector and
improve competitiveness of Indian industry in general and manufacturing in
particular.

Technology up gradation schemes for various sectors such as small scale

industries, textiles, food processing etc.;


Industrial infrastructure up gradation programmes on cluster basis;
Easier access to inputs at competitive prices and rationalization and reduction in
duty rates.
Encouragement to foreign technology collaborations and liberalization of FDI in
manufacturing activities.

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

ORGANIZATION PROFILE

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

ORGANIZATIONAL PROFILE

Company profile

Sri Sai Packaging was established in 2002 in mysore, Karnataka and is now rated
among the leading Corrugated Box Manufacturers, karnataka. Under the leadership of
our Owner, Mr. Shiv sai, we are becoming the talk of the market as reliable
Corrugated Boxes Manufacturers and Suppliers. These Wholesale Corrugated Boxes
are used in various industries for packaging and wrappingandwoodencartonboxes.

Infrastructure
We have a well-established infrastructure which is equipped with the latest high tech
machinery. The machinery helps in the on-time production of all our products. We
also have a spacious warehouse which is well arranged to store bulk products.

Team
We have a team of highly qualified and dedicated professionals. These professionals
are well versed with the latest technology. They work in coordination to produce the
desired products. The logistics team takes care of on-time delivery of these products.

QualityAssurance
We test for all our raw materials before production. The products go through rigorous
test at every stage from manufacturing to packaging and delivery. All our products
are thoroughly checked by our quality controllers to let the flawless products reach
the clients.

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

Name of Owner : Mr. Shiv sai


Year of Establishment : 2002
Nature of Business : Manufacturer & Supplier

Packaging Products manufactured by us are known for their strength and durability.
Our range of Packaging Products includes Corrugated Boxes. These Packaging
Products are widely used in various industries like Automotive, Pharmaceutical,
Cosmetic, Ceramic and many more for transportations and storage purposes. Our
Packaging Products are well cushioned to give them shock resistance characteristics
keeping the product inside them safe. We also offer customization of Corrugated
Boxes. Our Packaging Products last long when compared to others. These Packaging
Products are available in various sizes.

Qualitative And Eco-Friendly Wooden Products


Sai packaing does not need any introduction in the field of Manufacturing and
Supplying of Wooden Boxes and Crates. The company has an active presence with
substantial client base which is spread not only in karnataka but in the other markets
as well. The assortment of Wooden Products offered by us includes Wooden Pallets,
Euro Pallets, Wooden Packaging Boxes, Heavy Wooden Packaging Boxes, Wooden
Crates, Wooden Packing Cases and various others.

A quality and performance driven company, we have been striving hard to offer
immaculate quality. By adhering to the principle of consistency in the business
protocol, the products range that we offer is superior in quality and at par with
international standards. We have a well established business network that helps in the
smooth and effective functioning of the business. The positive feedbacks from clients
have also played a vital role in adding latest features to the wooden boxes and pallets.
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Last but not the least; we are also looking forward to establish and maintain long
lasting relationship with our esteemed clients.

Organizational Strategy
A definite organizational strategy has to be in place before beginning the
process of identifying actual costs within the manufacturing process, as well as
implementing a plan once those costs are identified.
Although a small company or a company with only a product or two may be
able to dive right into ABC analysis and implementation, a larger organization must
do some careful planning before beginning. Sometimes, a pilot project using only
product or department is an ideal place to start. This allows the ABC pilot project
team to get some experience as well as hopefully providing some semi-rapid results
that can be utilized in the short-term, thereby proving the effectiveness of the method.
(Tarr) According to the OSD Comptroller iCenter website, which provides financial
services information for the Department of Defense, there are four steps to ABC
implementation:
1. Identify activitiesperform an in-depth analysis of the operating processes of
each responsibility segment. Each process may consist of one or more
activities required by outputs.
2. Assign resource costs to activitiesthis is sometimes called "tracing."
Traceability refers to tracing costs to cost objects to determine why costs were
incurred. DoD categorizes costs in three ways:
a. Directcosts that can be traced directly to one output. Example: the
material costs (varnish, wood, paint) to build a chair.
b. Indirectcosts that cannot be allocated to an individual output; in
other words, they benefit two or more outputs, but not all outputs.
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Examples: maintenance costs for the saws that cut the wood, storage
costs, other construction materials, and quality assurance.)
c. General & Administrativecosts that cannot reasonably be associated
with any particular product or service produced (overhead). These
costs would remain the same no matter what output the activity
produced. Examples: salaries of personnel in purchasing department,
depreciation on equipment, and plant security.
3. Identify outputsidentify all of the outputs for which an activity segment
performs activities and consumes resources. Outputs can be products,
services, or customers (persons or entities to whom a federal agency is
required to provide goods or services).
4. Assign activity costs to outputsassign activity costs to outputs using activity
drivers. Activity drivers assign activity costs to outputs based on individual
outputs consumption or demand for activities. For example, a driver may be
the number of times an activity is performed (transaction driver) or the length
of time an activity is performed (duration driver). (OSD Comptroller iCenter)

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TYPES OF THE WOODEN CARTON BOXES

LIST OF CUSTOMERS
Cummins Generator Technologies, India
Motorsense, U.K
Cummins Generator Technologies, Mexico
Fasco Motors, USA
ABB Ltd, Bangalore
OITS Elevator company, India
Trident Power craft Pvt.Ltd, Hubli

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Kirloskar Electric co. Hubli


Mallik Engineering , Bangalore
Telco Construction Equipment, Dharwad

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ACTIVITY BASED COSTING FOLLOWED IN SAI PACKING LTD

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RESEARCH METHODOLOGY

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RESEARCH METHODOLOGY

The Study:
The present study is an attempt to understand and ascertain the costing method
followed in Sai packing ltd,mysore and to compare it with the costing method
Activity Based Costing.

Objectives of the study:


To study the functions and operations of the organization
To know and understand the existing costing method followed by SAI
PACKING LTD,MYSORE.
To identify activities involved in manufacturing of wooden carton 4x6.
To identify cost of the activities involved in manufacturing the product
wooden carton 4x6.
To allocate the cost for the activities.
To find the cost per unit of the product wooden carton 4x6.
To compare existing costing method followed by SAI PACKING
LTD,MYSORE with Activity Based Costing.

Scope of the study:


The scope of this study is to know and understanding the various processes and
activities involved in manufacturing Industries especially in SAI PACKING
LTD,MYSORE. It involves finding out the cost per unit of the product wooden
carton 4x6 by following Activity based Costing.

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Need for the study:


The theoretical aspects of ACTIVITY BASED COSTING provide the framework of
the study. A conceptual and the practical approach is the need of the hour. Hence the
field study becomes as essential part of the curriculum. Thus this project study
conducted to integrate theoretical and practical aspects of Activity based costing in
the organization.

DATA COLLECTION

Primary Data

Following are the sources of primary data collected.


Much of the information was collected from the cost accountant of SAI
PACKING LTD,MYSORE .
Frequent discussions were made with other employees of the company.
Met few senior level executive of the firm.

Secondary Data
Secondary data was collected through last years balance sheet of SAI
PACKING LTD,MYSORE.
Books on cost accounting were referred.
Company website

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Limitations of the study:


The study is limited to SAI PACKING LTD,MYSORE only.
In order to maintain confidentiality some information could not be
disclosed by sai packaing ltd.

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CONCEPTUAL FRAMEWORK

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About cost structure


The expenses that a
firm must take into account whenmanufacturing a product or providing a service.
Types of coststructures include transaction costs, sunk costs, marginal
costs and fixed costs. The cost structure of the firm is theratio of
fixed costs to variable costs.

Historical development of activity based costing


Traditionally, cost accountants had arbitrarily added a broad percentage of analysis
into the indirect cost. In addition, activities include actions that are performed both by
people and machine. However, as the percentages of indirect or overhead costs rose,
this technique became increasingly inaccurate, because indirect costs were not caused
equally by all products. For example, one product might take more time in one
expensive machine than another productbut since the amount of direct labor and
materials might be the same, additional cost for use of the machine is not being
recognized when the same broad 'on-cost' percentage is added to all products.
Consequently, when multiple products share common costs, there is a danger of one
product subsidizing another.
ABC

is

based

on

George

Staubus'

Activity Costing

and

Input-Output

Accounting. The concepts of ABC were developed in themanufacturing sector of the


United States during the 1970s and 1980s. During this time, the Consortium for
Advanced Management-International, now known simply as CAM-I, provided a
formative role for studying and formalizing the principles that have become more
formally known as Activity-Based Costing.
Robin Cooper and Robert S. Kaplan, proponents of the Balanced Scorecard, brought
notice to these concepts in a number of articles published in Harvard Business
Review beginning in 1988. Cooper and Kaplan described ABC as an approach to
solve the problems of traditional cost management systems. These traditional costing
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systems are often unable to determine accurately the actual costs ofproduction and of
the costs of related services. Consequently managers were making decisions based on
inaccurate data especially where there are multiple products.
Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify
cause and effect relationships to objectively assign costs. Once costs of the activities
have been identified, the cost of each activity is attributed to each product to the
extent that the product uses the activity. In this way ABC often identifies areas of
high overhead costs per unit and so directs attention to finding ways to reduce the
costs or to charge more for costly products.
Activity-based costing was first clearly defined in 1987 by Robert S. Kaplan and W.
Bruns as a chapter in their book Accounting and Management: A Field Study
Perspective. They initially focused on manufacturing industry where increasing
technology and productivity improvements have reduced the relative proportion of
the direct costs of labor and materials, but have increased relative proportion of
indirect costs. For example, increased automation has reduced labor, which is a direct
cost, but has increased depreciation, which is an indirect cost.
Like manufacturing industries, financial institutions have diverse products and
customers, which can cause cross-product, cross-customer subsidies. Since personnel
expenses represent the largest single component of non-interest expense in financial
institutions, these costs must also be attributed more accurately to products and
customers. Activity based costing, even though originally developed for
manufacturing, may even be a more useful tool for doing this.
Activity-based costing was later explained in 1999 by Peter F. Drucker in the
book Management Challenges of the 21st Century. He states that traditional cost
accounting focuses on what it costs to do something, for example, to cut a screw
thread; activity-based costing also records the cost of not doing, such as the cost of
waiting for a needed part. Activity-based costing records the costs that traditional cost
accounting does not do.
The overhead costs assigned to each activity comprise an activity cost pool.

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ABOUT ACTIVITY BASED COSTING


Cost accounting approach concerned with matching costswith activities (called cost
drivers) that cause those costs. It is a more sophisticated kind of absorptioncosting and

replaces labor based costing

system.

ABC states that

(1)products consume activities, (2) it is the activities (and not the products) that
consume resources, (3) activities are the cost drivers, and (4) that activities are not
necessarily based on the volume of production. Instead of allocating costs to cost
centers (such
and indirect

as manufacturing, marketing,
costs to

activities

such

finance),

as processing an

ABC allocates direct


order,

attending

to

a customercomplaint, or setting up a machine. A subset of activity based management


(ABM), it enables management to better understand (a) how and where the firm
makes aprofit, (b) indicates where money is being spent and (c) which areas have the
greatest potential for cost reduction.Developed by professors Robert Kaplan and
Robin Cooper of Harvard University in late 1980's.
Activity Based Costing (ABC) is an accounting technique that allows an organization
to determine the actual cost associated with each product and service produced by the
organization without regard to the organizational structure. It is developed to provide
more-accurate ways of assigning the costs of indirect and support resources to
activities, business processes, products, services, and customers. ABC systems
recognize that many organizational resources are required not for physical production
of units of product but to provide a broad array of support activities that enable a
variety of products and services to be produced for a diverse group of customers. The
goal of ABC is not to allocate common costs to products. The goal is to measure and
then price out all the resources used for activities that support the production and
delivery of products and services to customers.
Concept of Activity-Based-Costing:
An organization performs activities to do its business. These activities define the kind
of business you are in: a ship owner has an activity to unpack boats; an accounting
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firm prepares tax returns; a manufacturer produces products; a council delivers


services; a university teaches students. All activities consume resources. It is the
consumption of these resources that adds to overhead costs.
The basis of Activity Based Costing is look at the activities required to produce the
cost of the product or service. The activities consume resources and the cost of these
can be calculated. The amount of activity required for each product and service is
determined, hence the real cost can be determined.

Activity Based Costing Definition


ABC can be defined by the following equation:
C/A = HD + M + E + S
where C/A = Estimated cost per activity
H = Number of labor hours required to perform the activity one time
D = Wages per labor hour
M = Material costs required to perform the activity one time
E = Equipment costs to perform the activity one time
S = Subcontracting costs to perform the activity one time
The total cost for performing the activity will be based on the number of times the
activity is performed during a specific time frame.

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What's in ABC?

The activity is the work that is done.

The resource is what the activity uses to do the work e.g. people, equipment,
and services. Resources cost money.

The cost of the activity depends on the quantity of resources used to


accomplish the activity.

The cost driver for an activity is the factor that influences the amount of the
resources that will be consumed by this activity.
Example: the activity is delivering goods. The costs of this activity include the
truck drivers' wages, fuel, depreciation of the truck, insurance, etc. The
quantities of the resources that will be consumed by this activity are influenced
by the number of deliveries made per year. Hence the cost driver could be the
number of deliveries. A cost driver is designed to allocate the delivery activity
cost pool to the cost objects.

The activity driver measures how much of the activity is used by the cost
object. Example: Product A is delivered once a month, whereas product B is
delivered once a week. Products A and B require a different number of
deliveries, hence the cost of the delivery activity should be assigned to each
product on the basis of the number of deliveries each uses.

The cost object is whatever it is you wish to cost. It could be a product,


service, process, job or customer.

While traditional costing arbitrarily allocates overhead costs, ABC traces overhead
costs by looking at the activities that each product and service calls upon. With ABC
the products consume the activities. It is the activities that cost money.

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Why use Activity-Based-Costing?


Activity-Based-Costing is necessary for the following reasons.
Understand true profitability of your customers, products, or services
Quantify the cost of non-value added activities such as errors and
reworks
Identify opportunities to reduce costs and/or increase efficiency
Obtain actionable information to negotiate price increases for
unprofitable clients
Stratify overhead costs so they can be managed more effectively.

The ABC framework


Activity based costing has been claimed as a method of arriving at more accurate
costs, often in order to set selling prices. In a market economy, the idea of selling
prices based on costs is dangerous, with serious consequences for a business

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competitive stance. With the variety of conventions and concepts used in cost
determination, there are no absolutes in determining product costs, hence the
objective of accurate costs is diluted. However, the technique of ABC is being seen
more as a cost-distortion alarm; more as an attention directing tool; more as a cost
management tool.

Activity Based Costing is a methodology for understanding the activities, processes,


services and products of a business; understanding what drives the cost of these
activities and processes; and thus reducing the non-value-adding activities/processes.

The Elements of ABC can be described in the following model:

The ABC CROSS:

COST ASSIGNMENT VIEW


RESOURCES
31

RESOURCE
DRIVERS

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COST
DRIVERS

ACTIVITIES

ACTIVITY
DRIVERS

OBJECTS
OF WORK

PERFORMANCE
MEASURES

Resource Drivers are the link between resources and activities assigning cost form the
financial statements.

Activity Driver is the factor used to assign cost from an activity to a object of work,
for instance, if making a sales call is the activity then the frequency of sales calls to a
specific customer/client would be the activity driver.

Object of Work is the specific objective at the end of a process, for instance, a
product, a satisfied customer/client.

Cost Drivers are factors that cause changes in the performance of activities and create
increased consumption of resource. Fundamentally there are two types of Cost
Drivers. The Structural Cost Drivers are viz. Scale, Scope, Experience, Technology
and Complexity. The Exceptional Cost Drivers are viz. Work Force Involvement,
Total Quality Management, Capacity Utilization, Plant Layout, Electricity, Product
Configuration and Exploiting Value Chain Linkages.

Activities comprise of units or work or task. For example purchase of raw materials,
activities involved in manufacturing etc.

ABC categorizes the activities into:


Unit level activities:
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Performed each time a unit is produced.

Consumed in direct proportion to the number of units produced.

E.g. Direct materials, Energy costs, direct labour, etc.

Batch related activities:

Performed each time a batch of goods is produced.

Consumed in direct proportion the number of batches produced.

Fixed for all units within a batch.

E.g. set up resources, purchasing resources.

Product sustaining activities:

Performed to support and sustain different products/services on the product


life cycle.

Consumption varies with the variety of products/services and the stage of the
Product Life Cycle the products/services are in.

E.g. designing the product.

Facility sustaining activities:

Performed for supporting the happening of the above three types of activities
and providing the platform/infrastructure.

These are generally fixed for a certain scale/scope of operations over a period
of time.

E.g. Administration, plant maintenance, accounting, etc.

These costs are deducted lump sum from operating margins of all product
lines.

ABC establishes inputs and outputs to and from each activity, Inputs to one activity
may be outputs from another and there could also be interactive relationships among
activities.
Hierarchy of Activities and Activity based profitability analysis
Sales Revenue
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Less: Unit-level products cost


(Material, Power Costs, Other identifiable costs)
=

unit level contribution

Less: Batch related costs


(Sets-ups, material movements, purchase orders, inspection)
=

batch level contribution

Less: Product line costs


(Process engineering, product specifications, order change notices)
=

product line contribution

Less: Consumer and market related costs


=

customer level contribution

Less: Facility sustaining cost


(Plant management , rent , rates, and taxes, etc.,)
=

net profit

Note: Unit level and batch contribution analysis facilitate short-term decision relating
to products and complexity analysis. Product line contribution helps in product line
decisions. Customer level contribution helps in customer and market related
decisions. Facility sustaining cost are period cost are period which are fixed in nature.

STAGES OR STEPS INVOLVED IN ACTIVITY BASED COSTING.

Step 1: Identify the various activities within the organization. Activities comprise of
units of work or task. For example purchase of material is an activity consisting of

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series of task like purchase requisition, advertisement, inviting quotations,


identification of suppliers, issuing purchase orders, follow up etc.

Step 2: Relate the overheads to the activity using resource cost drivers
a) Over heads will be related to support and primary activities.
b) For this purpose, resource cost drivers will be used.
c) All costs will be identified under the activities, thus creating activity cost
pools.

Step 3: Apportion the cost to support activities over the primary activities on suitable
basis.
a) This is very much like reapportionment of service department expenses to
production departments.
b) Cost of support activities are spread over to primary activities to collect costs
only under them.
c) The base is the cost driver which is the measure of how the support activities
are used.

Step 4: Determine the activity cost drivers for activity/cost pools.


a) Activity cost drivers used to relate the overheads collected in the cost pools
to cost objects should be determined.
b) This is based on the factor that drives the consumption of the activity.
c) For example, in production scheduling, the driver will be the number of
batches ordered.

Step 5: Calculate Activity cost driver rate = Total cost of activity


Activity cost driver
a) Activity cost driver rates are computed for each activity.

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b) The rates will be multiplied by the different amounts of each activity that
each product/other cost object consumes so as to ascertain its cost.
c) This rate can be used to ascertain cost of the product (as in traditional
absorption costing) and to ascertain cost of other cost objects such as
customers/customer segments and distribution channels.
d) Cost drivers are selected based on three criteria:
e) (1) Causal relation. Ideally, choose a cost driver that causes the cost. This is the
best cost
f) drive available.
g) (2) Benefits received. Choose a cost driver to assign costs in proportion to
benefits
h) received.
i) (3) Reasonableness or fairness. When the first two criteria fail, assign costs on the
basis
j) of fairness or reasonableness.
k) For any indirect cost, a predetermined rate can be computed as follows:
l) Predetermined rate = Estimated indirect cost
m) Estimated volume of allocation base
n) .
o) For activity-based costing, the first stage consists of activities. Each activity has
an
p) associated cost pool and requires a cost driver rate using the formula above.
q) The second stage in a two-stage system using activity-based costing allocates
costs to
r) products by multiplying the cost driver rates by the number of units of the cost
driver (i.e.,
s) volume of activities) consumed in each product..
t) The distinctive feature of activity-based costing is that it recognizes that
overhead costs
u) are caused by activities and that activities may not be caused solely by volume,
but by
v) other types of activities. Cost drivers for the activities should reflect the cost
incurrence
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w) in the activity, even if cost is not caused by volume.

Aims of model
With ABC, a company can soundly estimate the cost elements of entire products
ACTIVITIES and services. That may help inform a company's decision to either:

Identify and eliminate those products and services that are unprofitable and lower
the prices of those that are overpriced (product and service portfolio aim)

Or identify and eliminate production or service processes that are ineffective and
allocate processing concepts that lead to the very same product at a better yield
(process re-engineering aim).

In a business organization, the ABC methodology assigns an organization's


resource costs through

activities

to

the products andservices provided

to

its

customers. ABC is generally used as a tool for understanding product and customer
cost and profitability based on the production or performing processes. As such, ABC
has predominantly been used to support strategic decisions such as pricing,
outsourcing, identification and measurement of process improvement initiatives.

Prevalence
Following initial enthusiasm, ABC lost ground in the 1990s, to alternative metrics,
such as Kaplan's balanced scorecard and economic value added. An independent
2008 report concluded that manually driven ABC was an inefficient use of resources:
it was expensive and difficult to implement for small gains, and a poor value, and that

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Activity Based Costing as a measure of improving the cost structure at SAI


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alternative methods should be used.[2] Other reports show the broad band covered
with the ABC methodology.[3]

Alternatives
Lean accounting methods have been developed in recent years to provide relevant
and thorough accounting, control, and measurement systems without the complex and
costly methods of manually driven ABC. However lean accounting is a snapshot
concept for capturing just partial derivatives or differentials of selected cost
functions. Lean accounting takes an opposite direction from ABC by working to
eliminate peculiar cost allocations rather than apply complex methods of resource
allocation.
Lean accounting is primarily used within lean manufacturing. The approach has
proven useful in many service industry areas including healthcare, construction,
financial services, governments, and other industries.
Application of Theory of constraints (TOC) is analysed in a study showing interesting
aspects of productive coexistence of TOC and ABC application. Identifying cost
drivers in ABC is described as somewhat equivalent to identifying bottlenecks in
TOC. However the more thorough insight into cost composition for the inspected
processes justifies the study result: ABC may deliver a better structured analysis in
respect to complex processes, and this is no surprise regarding the necessarily spent
effort for detailed ABC reporting.

Methodology
Methodology of ABC focuses on cost allocation in operational management. ABC
helps to segregate

Fixed cost

Variable cost

Overhead cost
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Activity Based Costing as a measure of improving the cost structure at SAI


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The split of cost helps to identify cost drivers, if achieved. Direct labor and materials
are relatively easy to trace directly to products, but it is more difficult to directly
allocate indirect costs to products. Where products use common resources differently,
some sort of weighting is needed in the cost allocation process. The cost driver is a
factor that creates or drives the cost of the activity. For example, the cost of the
activity of bank tellers can be ascribed to each product by measuring how long each
product's transactions (cost driver) takes at the counter and then by measuring the
number of each type of transaction. For the activity of running machinery, the driver
is likely to be machine operating hours. That is, machine operating hours drive
labour, maintenance, and power cost during the running machinery activity.
Application in routine business
ABC has proven its applicability beyond academic discussion. ABC is applicable
throughout company financing, costing and accounting:

ABC is a modeling process applicable for full scope as well as for partial views.

ABC helps to identify inefficient products, departments and activities.

ABC helps to allocate more resources on profitable products, departments and


activities.

ABC helps to control the costs at any per-product-level level and on a


departmental level.

ABC helps to find unnecessary costs that may be eliminated.

ABC helps fixing the price of a product or service with any desired analytical
resolution.

A reports summarizes reasons for implementing ABC as mere unspecific and mainly
for case study purposes (in alphabetical order):

Better Management

Budgeting, performance measurement

Calculating costs more accurately

Ensuring product /customer profitability


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Activity Based Costing as a measure of improving the cost structure at SAI


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Evaluating and justifying investments in new technologies

Improving product quality via better product and process design

Increasing competitiveness or coping with more competition

Management

Managing costs

Providing behavioral incentives by creating cost consciousness among employees

Responding to an increase in overheads

Responding to increased pressure from regulators

Supporting other management innovations such as TQM and JIT systems

Beyond such selective application of the concept, ABC may be extended to


accounting, hence proliferating a full scope of cost generation in departments or
along product manufacturing. Such extension, however requires a degree of
automatic data capture that prevents from cost increase in administering costs.
Activity Based Costing Pros & Cons
Pros
Identifies Non-Value Added Activities
Identifies cost savings opportunities (untraceable costs)
Provides very detailed cost/profitability information
Differentiates complex versus simple processes
More data can lead to more information = better decisions

Cons
Very costly to implement and maintain
Historical in nature (same as traditional absorption costing)
Detail versus Accuracy (GIGO)
Discourages novel approachs to processes
Encourages activity
Assumes equal and proportionate benefits result from common activity
Steps to implement Activity-Based costing
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1. Identify and assess ABC needs - Determine viability of ABC method within an
organization.
2. Training requirements - Basic training for all employees and workshop
sessions for senior managers.
3. Define the project scope - Evaluate mission and objectives for the project.
4. Identify activities and drivers - Determine what drives what activity.
5. Create a cost and operational flow diagram How resources and activities are
related to products and services.
6. Collect data Collecting data where the diagram shows operational
relationship.
7. Build a software model, validate and reconcile.
8. Interpret results and prepare management reports.
9. Integrate data collection and reporting.

Integrating EVA and PBC


Recently, Mocciaro Li Destri, Picone & Min (2012) proposed a performance and
cost measurement system that integrates the EVA criteria with Process Based Costing
(PBC). Authors note that activity-based costing system is introspective and focuses
on a level of analysis which is too low. On the other hand, they undescore the
importance to consider the cost of capital in order to bring strategy back into
performance measures.

Limitations

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Applicability of ABC is bound to cost of required data capture. That drives the
prevalence to slow processes in services and administrations, where staff time
consumed per task defines a dominant portion of cost. Hence the reported application
for production tasks do not appear as a favorized scenario.

ABC Implementation Issues:


Another refinement in product costing that often accompanies implementation of
ABC focuses on step of the five-step product costing sequence: identify the direct
costs associated with the cost object. The refinement involves the following. For a
given cost object, the company attempts to identify costs currently treated as
overhead that have not beenbut can betraced directly to the cost object. In other
words, costs are moved from the overhead cost pool to the direct cost category. For
example, an accounting firm might take certain office-support expenses formerly
treated as overhead, such as printing and copying, and start tracking and assigning
these costs to specific jobs (audits, tax engagements, etc.) for internal reporting and
profitability analysis (but not necessarily for client billing purposes).

The successful implementation of ABC usually requires participation by managers


from non-accounting functions, such as production and marketing. Because ABC
focuses on activities, and activities often cut across departments and functional areas,
implementing ABC can improve lines of communication and cooperation within the
company. On the other hand, more accurate cost allocation does not, by itself, reduce
costs. The initial move from a traditional costing system to ABC usually shifts
overhead costs from some products to other products, with some managers winning
and some losing. Some companies have found that hiring an outside consulting
firm to assist with the ABC adoption facilitates obtaining buy-in by managers and
employees throughout the company. Perhaps partly for this reason, ABC

implementation has become an important consulting product for accounting firms and
for many consulting firms.

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Although ABC should provide the company more accurate information, it is not a
panacea; some companies that invested time and money implementing ABC did not
realize the benefits they expected. Some of these companies have reverted to simpler,
more traditional costing systems.

ACTIVITY BASED COSTING ADVANTAGES

More accurate costing of products/services, customers, distribution channels.

Better understanding overheads.

Easier to understand for everyone.

Utilizes unit cost rather than just total cost.

Integrates well with Six Sigma and other continuous improvement programs.

Makes visible waste and non-value added.

Enables costing of processes, supply chains, and value streams

Activity Based Costing mirrors way work is done

Facilitates benchmarking.

ACTIVITY BASED COSTING DISADVANTAGES

More time consuming to collect data.

Cost of buying, implementing and maintaining activity based system.

Makes waste visible which some executives and managers don't want their
boss to see.

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How does Activity Based Costing differ from traditional cost accounting systems?
Most traditional costing systems utilize a single basis, (e.g. direct labor) to distribute
the indirect costs to all products and services. This method of allocating indirect costs
commonly results in erroneous cost data. Often products which have high volume
(and high labor cost) are over costed. Likewise, the cost of lower volume products are
often understated, and many of the indirect costs of these products are overlooked.
Rather than relying on a single basis to distribute costs, ABC assigns costs to
activities and products based on how the costs (resources) are actually consumed by
the process or product. By moving away from traditional cost allocation methods and
using improved ABC methods of tracing and assignment, ABC provides managers
with a clearer picture of cost of processes and the profitability of customers and
products.
ABC Output ABM Decision Making Tools
Product and Customer Profitability
Revenues
Less Traceable Costs
Excess Revenues over Traceable Costs
Less Untraceable Costs

(Total Costs less Traceable Costs)

Operating Income

Departmental Efficiency
Actual Costs Incurred versus Traceable Costs Assigned
If Traceable > Actual, department was efficient
If Traceable < Actual, department was inefficient
Strengths and Weaknesses
While the thought behind ABC makes sense, and the results would be of great
benefit for many companies, there are still some inherent problems with the
methodology.

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In some instances, costs can be defined, but where and how to assign them can
be extremely difficult. An example would be the salary of the companys CEO. This
is difficult to assign because there is no solid method of doing so. (Wikipedia.org)
Just because a cost cannot be assigned to a product or products does not mean that the
ABC method is seriously flawed and should be abandoned. According to Robert
Kaplan, one of the founding fathers of ABC, small inconsistencies are acceptable.
The objective is to be approximately right. (Kaplan and Anderson)
A strength of ABC, as has been mentioned throughout this paper, is having a
better understanding of what indirect or overhead costs go into the cost of a product.
Knowing exactly how much time and materials go into a product from all areas
instead of just the ones that are obvious is of great value to any organization. It leads
to more efficient processing in the manufacturing process, which in turn leads to
greater profits through realization of cost savings.
Specific Applications
There are too many specific applications of ABC to be listed here, but it will
suffice to say that many industries could see benefits from implementing an ABC
method, or at the very least identifying actual costs within a process.
One interesting example I found through my research was how United States
shipyards were being compared to Northern European shipyards in their conversion
from mainly military use to commercial shipbuilding. A large part of this study
required determining hidden costs within the process that are the result of bloat and
financial sloppiness that are inherent in the fulfillment of government contracts.
(Kvaerner Masa Marine INC Annapolis MD)
Conclusion
In conclusion, we can see that the methodology behind Activity-Based Costing
is sound, and can result in sometimes great savings to a company willing to take the
time, effort and expense to implement a plan. Although there are some pitfalls to the
process, with perseverance and a solid commitment from management, ABC can be
of great benefit to a manufacturing company.

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ANALYSIS

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Activity Based Costing as a measure of improving the cost structure at SAI


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DETAILS OF THE PRODUCT

Product name: wooden carton 4x6

Raw Material Requirements for the product

1) wooden sheet of length 1250*2500*1.2mm


2) Weight of the sheet is 30kg
3) 21 cartons can be prepared from one sheet.
4) Sheets required to prepare 1000 units is 48sheets.
5) Cost of sheet per kg 37Rs.
6) Weight of a Cover

= 30kg/21
=1.42kg

7) Gross Material cost per unit

= 1.42 x Rs55
= Rs78.1/Cover

8) Process Generated Scrap

=0.65 kgs

9) Scrap rate

=Rs12/kg

10) Revenue generated from scrap = 0.65 x 10


= Rs 6.5
11) Net material cost

= 78.1 6.5
= Rs71.6

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Activity Based Costing as a measure of improving the cost structure at SAI


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COSTING FOLLOWED BY THE COMPANY


Product: wooden carton 4x6
Number of units produced = 300000 cartons p.a

Particulars

Total

Cost/unit

cost(in Rs)

(in Rs)

DIRECT COST
Direct Material (Raw Material Consumed)

3,05,73,918

Direct Wages

18,93,573

Direct Expenses

45,65,266

Prime Cost

3,70,32,757

123.4

31,45,069

10.48

FACTORY OVERHEADS
fuel oil & lubricant

1,58,029

Depreciation on machinery

8,04,853

Repairs and maintenance

3,91,235

Insurance

56,147

Rates and Taxes

2,61,532

Indirect material

14,73,273

Factory cost
ADMINISTRATIVE OVERHEADS
Printing and stationary

69,255

Postage and telegram

18,929

Newspapers and magazines

5,964

Professional charges

27,619

Office furniture

5,646

Leave with wages

7,095

Telephone expenses

1,75,338

Salary to partners

14,60,000
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Activity Based Costing as a measure of improving the cost structure at SAI


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Vehicle maintenance

72,347

Sundry expenses

84,809

Salary to staff

2,59,203
21,86,205

Cost Of Goods Sold

7.28

SELLING AND DISTRIBUTION


Advertisement expenses
Traveling expenses

3,410
1,82,480

Sales Promotion expenses


Packing charges

5,500
4,97,360

6,88,750
4,30,52,781

143.50

PROFIT

52,81,095

17.6

SALES

4,83,33,876

161.1

Cost Of Sales

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Activity Based Costing as a measure of improving the cost structure at SAI


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CALCULATION OF COST PER UNIT BY ACTIVITY BASED COSTING


1) Purchase of Raw material
Activity

Sub Activity

Cost Driver

Purchase

Raw material transport

Weight of product

Loading and unloading

Weight of product

Storage

Weight of product

Material cost

Weight of product

a) Raw material transport charges :


Weight of the goods 5000kgs (for the specified component) of sheet wooden
Delivered from J.P Nagar mysore to SAI PACKING LTD,MYSORE = Rs.600.00

Therefore charges per unit

= Rs600/5000kgs
= Rs0.12/kg

Cost of per carton

=1.42kg x Rs0.12
=Rs0.1704/carton

b) Loading and unloading Charges = Rs300.00/ton

5 Ton x Rs300

= Rs1500.00

Therefore charges for per unit

= Rs1500/5000kgs
= Rs0.20/kg

Cost per carton

=1.42 x Rs0.20
=Rs0.284/carton

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Activity Based Costing as a measure of improving the cost structure at SAI


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c) Storage charges

= space required 10 x 5ft

Rent 20000/month
Building area

= 10000sq ft

Storage Cost

=50sq ft x Rs2.00
=Rs100.00/- p.m

Storage cost per day

=Rs100/26Days
=Rs3.84/day

Storage cost per Cover

=Rs3.84/1000Covers
=Rs0.00384/cover

d) Material cost

= 5000kgs x Rs 71.28 (exclusive of


transport and loading and unloading
charges)
= Rs3,56,400
=5000kgs/1.42wt per kg
=3521 Covers
=Rs3,56,400/3521cartons
=Rs101.22 scrap
=Rs101.22 Rs6.5
=Rs94.72/cartons

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Total cost incurred for purchase of raw material


Activity

Sub Activity

Purchase

Raw material transport


Loading and unloading

Cost
Rs0.1704/carton
Rs0.284/carton

Storage

Rs0.00384/carton

Material cost

Rs 94.72/carton
Rs95.17

Total

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2) Manufacturing cost

Activity

Sub Activity

Manufacturing

Shearing

Activity Driver
Combination of man and
machine hour
Combination of man and

Circle cutting

machine hour
Combination of man and

Deep drawing

machine hour
Combination of man and

Trimming

machine hour
Combination of man and

Piercing

machine hour

2) Manufacturing cost

Number

Process

labo

Wages

per day

Hours

Circle
cutting
Deep
drawing

300/wo
rker
150
150
&135

Cost
per sq

of

Cost of

Hp per

occupie

Covers

Machin

machin

d by the ft

per 8

hrs
Shearing

Space

1000

500000

800

100000

0.5

800

800000

53

machin

100 sq

Rs2

ft
50 sq ft

Rs 2

100sq ft Rs 2

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

Trimming

150

500

300000

Piercing

150

900

400000

80sq ft

Rs 2

50 sq ft

Rs 2

COST OF EACH PROCESS

1) Shearing

a) Man cover rate:

= wages/number of Covers
= Rs900/1000Covers
= 0.9/Cover rate

b) Machine cover rate

=cost of machine x depreciation


=Rs500000 x 10% depreciation
=Rs50000 p.a
=Rs50000/300days
= Rs166.6per day
=Rs166.6/1000Covers
=Rs0.17/Cover

c) Space occupied by

= 100 Sq ft x Rs 2 per sq ft

the machine
= Rs200 p.m
= Rs200/26days
=Rs7.69/day
=Rs7.69/1000Covers
=Rs 0.00769/Cover

d) calculation of electricity
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Activity Based Costing as a measure of improving the cost structure at SAI


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Monthly electricity bill

= 31,266

Monthly power consumption = 45hp


Therefore,
Rs31,266/45hp = Rs694.8 per hp/ month

Power Consumption

= 5hp

For 5hp = Rs694.8 x 5hp


Electricity bill per month

= Rs3,474
= Rs3474.00
= Rs3474/26days
=133.61/day
=133.61/1000
=Rs0.1336/Cover

Fuel oil & lubricants

= Rs1,58,028 p.a
= Rs 158028/ 300days
= Rs 526.76/day
= Rs 526.76/25machines
=Rs21.07/machine
=21.07/1000Covers
=0.021/Cover

Total Cost of shearing activity

Activity

Sub Activity

Shearing

Man cover rate


Machine cover rate

55

Cost
Rs0.9/carton
Rs0.17/carton

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

Space occupied by the

Rs0.00769/ carton

machine
electricity

Rs0.1336/ carton

Fuel oil & lubricants

Rs0.021/ carton
Rs 1.232/ carton

Total

2. Circle cutting

a) Man cover rate

=wages/number of Covers
= Rs150/800 carton
=Rs0.1875/ carton

b) Machine cover rate

=Rs100000 x 10% depreciation


=Rs10000 p.a
=Rs 10000/300days
=Rs33.33/per day
=Rs33.33/800 carton
=Rs0.0416/ carton

c) Space occupied by

= 50Sq ft x Rs 2 per sq ft

the machine
= Rs100 p.m
= Rs100/26days
=Rs3.84/day
=Rs3.84/800 carton
=Rs 0.0048/ carton

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e) calculation of electricity
Monthly electricity bill

= Rs31,266

Monthly power consumption = 45hp


Therefore,
Rs31,266/45hp = Rs694.8 per hp/ month
Power Consumption

= 0.5hp

For 0.5hp = Rs694.8 x 0.5hp


Electricity bill per month

= Rs347.4

= Rs347.4
= Rs347.4/26days
=13.36/day
=13.36/800 carton
=Rs0.0167/ carton

Fuel oil & lubricants

= Rs1,58,028 p.a
= Rs 158028/ 300days
= Rs 526.76/day
= Rs 526.76/25machines
=Rs21.07/machine
=21.07/800 carton
=0.026/ carton

Total Cost of circle cutting activity

Activity

Sub Activity

Circle cutting

Man cover rate

Cost
Rs0.1875/ carton

Machine cover rate

Rs0.0416/ carton

Space occupied by the

Rs0.0048/ carton

machine

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Activity Based Costing as a measure of improving the cost structure at SAI


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electricity

Rs0.0167/ carton

Fuel oil & lubricants

Rs0.026/ carton
Rs0.2766/ carton

Total

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3. Deep drawing

a) Man hour rate

=wages/number of Covers
= Rs285/800 carton
=Rs0.3562/ carton

b) Machine hour rate

=Cost of machine x Depreciation


=Rs800000 x 10% depreciation
=Rs80000 p.a
= Rs80000/300days
=Rs266.67/per day
=Rs266.67/800 carton
=Rs0.333/ carton

c) Space occupied by

= 100Sq ft x Rs 2 per sq ft

the machine
= Rs200 p.m
= Rs200/26days
=Rs7.69/day
=Rs7.69/800 carton
=Rs0.0096/ carton

d) calculation of electricity
Monthly electricity bill

= Rs31,266

Monthly power consumption = 45hp


Therefore,
Rs31,266/45hp = Rs694.8 per hp/ month

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Power Consumption

= 7hp

For 7hp = Rs694.8 x 7hp


Electricity bill per month

= Rs4863.6
= Rs4863.6
= Rs4863.6/26days
=187.06/day
=187.06/800 carton
=Rs0.233/ carton

Fuel oil & lubricants

= Rs1,58,028 p.a
= Rs 158028/ 300days
= Rs 526.76/day
= Rs 526.76/25machines
=Rs21.07/machine
=21.07/800 carton
=0.026/ carton

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Total Cost of deep drawing activity

Activity

Sub Activity

Deep Drawing

Man cover rate

Cost
Rs0.3562/ carton

Machine cover rate

Rs0.333/ carton

Space occupied by the

Rs0.0096/ carton

machine
electricity

Rs0.233/ carton

Fuel oil & lubricants

Rs0.026/ carton
Rs 0.9578/ carton

Total

4. Trimming

a) Man hour rate

=Wages/number of Covers
= Rs150/500 carton
=Rs0.3/ carton

b) Machine hour rate

=Cost of machine x depreciation


=Rs300000 x 10% depreciation
=Rs30000 p.a
= Rs30000/300days
=Rs100/per day
=Rs100/500 carton
=Rs0.2/ carton

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c) Space occupied by

= 80Sq ft x Rs 2 per sq ft

the machine
= Rs160 p.m
= Rs160/26days
=Rs6.15/day
=Rs6.15/500 carton
=Rs 0.012/ carton

d) calculation of electricity
Monthly electricity bill

= Rs31,266

Monthly power consumption

= 45hp

Therefore,
Rs31,266/45hp = Rs694.8 per hp/ month
Power Consumption

= 3hp

For 3hp = Rs694.8 x 3hp

= Rs2084.4

Electricity bill per month

= Rs2084.4
= Rs2084.4/26days
=80.16/day
=80.16/500 carton
=Rs0.16/ carton

Fuel oil & lubricants

= Rs1,58,028 p.a
= Rs 158028/ 300days
= Rs 526.76/day
= Rs 526.76/25machines
=Rs21.07/machine
=21.07/500 carton
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=0.042/ carton
Total Cost of trimming activity

Activity

Sub Activity

Trimming

Man cover rate

Cost
Rs0.3/ carton

Machine cover rate

Rs0.125/ carton

Space occupied by the

Rs0.012/ carton

machine
electricity

Rs0.16/ carton

Fuel oil & lubricants

Rs0.042/ carton

Rs 0.639/ carton
Total

5. Piercing

a) Man hour rate


=Rs 150/900 carton
=0.166/ carton

b) Machine hour rate

=400000 x 10% depreciation


=40000 p.a
= 40000/300days
=133.33/per day
=133.33/900 carton
=0.148/ carton

c) Space occupied by

= 50Sq ft x Rs 2 per sq ft

the machine
= Rs100 p.m
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Activity Based Costing as a measure of improving the cost structure at SAI


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= Rs100/26days
=Rs3.84/day
=Rs3.84/900 carton
=Rs 0.0042/ carton

d) calculation of electricity
Monthly electricity bill

= Rs31,266

Monthly power consumption = 45hp


Therefore,
Rs31,266/45hp = Rs694.8 per hp/ month

Power Consumption

= 3hp

For 3hp = Rs694.8 x 3hp

= Rs2084.4

Electricity bill per month

= Rs2084.4
= Rs2084.4/26days
=80.16/day
=80.16/900 carton
=Rs0.089/ carton

Fuel oil & lubricants

= Rs1,58,028 p.a
= Rs 158028/ 300days
= Rs 526.76/day
= Rs 526.76/25machines
=Rs21.07/machine
=21.07/900 carton

=0.023/ carton

Total Cost of piercing activity

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Activity Based Costing as a measure of improving the cost structure at SAI


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Activity

Sub Activity

Piercing

Man cover rate

Cost
Rs0.166/ carton

Machine cover rate

Rs0.148/ carton

Activity

Sub Activity

Cost

Manufacturing

Shearing

Rs1.232/ carton

Circle cutting

Rs0.2766/ carton

Deep drawing

Rs 0.9578/ carton

Trimming

Rs 0.639/ carton

Piercing

Rs0.468/ carton
Rs3.5734/ carton

Total
Space occupied by the

Rs0.042/ carton

machine
electricity

Rs0.089/ carton

Fuel oil & lubricants

Rs0.023/ carton
Rs0.468/ carton

Total

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Total Cost of the processes

3) Inspection

Inspection rate 10% of number of units produced per day


1000 carton x 10% = 100 carton to be inspected

1) Salary of the inspector

= Rs8000/month

Time required to inspect


Per day salary

= 1 hour
= Rs8000/26days
=Rs307.69/day

Per hour salary

=Rs 307.69/8hRs
= Rs 38.46/hr

Wages to the inspector

= 1hr x Rs38.46
= Rs38.46/hr

2) Cost of instruments required to inspect

= Rs 8500

Expected life of instrument is one year


Instruments charges per month

= Rs8500/12months
= Rs708.33/month

Per day charges

= Rs708.33/26 days
= Rs 27.24/day

Per hour charges

= Rs27.24/8hrs
= Rs3.4/hr

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Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

3) Calibration charges per year


Per month charges

= Rs900
= Rs900/12months
= Rs75/month

Per day charges

= Rs75/26days
= Rs3/day

Per hour charges

= Rs3/8hr
=Rs0.375/hr

Total of inspection activity

Activity

Sub Activity

Inspection

Salary of the inspector


instruments required to
inspect
Calibration

Cost
Rs38.46/hr
Rs3.4/hr
Rs0.375/hr
Rs42.23/hr

Total
Cost of Per
Cover

67

Rs 0.0422/ carton

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

4) Painting
.
1) Cost of paint and thinner

Paint Rs250/ltr
Thinner Rs150/ltr
Divided in the ratio of 75:25
Cost of Paint

= Rs250 x 75/100
=Rs 187.5

Cost of Thinner

= Rs150 x 25/100
=Rs 37.5

Cost of mixture total

= Rs187.5 + Rs37.5
= Rs225

Total Area of component covered by the mixture is 45 sq ft


Area of the a component

= 1.72 sq ft

Covers that can be painted = 45sq ft/1.72sq ft


= 26Covers
Cost of paint per cover

=Rs225/ 26 carton
= Rs8.6/ carton

2) Labour cost
People required for painting

=2

Wages per day

= Rs 320

Covers painted in one day

= 200 carton

Cost per cover

= Rs320/200 carton
=Rs1.6/ carton

68

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

3) Paint booth operation cost

Deprecation

= Rs300000

= 20% of the cost


=Rs 300000 x 20%
= Rs60000p.a

Per month

= Rs60000/12months
=Rs5000p.m

Per day

= Rs5000/26days
= Rs192.3/day

Cost of per covers

=Rs 192.3/200 carton


=Rs0.961/carton

4) Power charges Rs 5500/month


Total Power consumption

=20hp

Therefore,
Rs5500/20hp

=Rs275per hp/month

Power consumption

=5hp

For 5hp

=5hp x Rs275

Electricity bill per month for 5hp =Rs1375


Per day charges

= Rs1375/26days
= Rs53/day

Per cover charges

=Rs53/200 carton
=Rs0.265/ carton

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Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

5) Area of painting booth

= 60 x 20ft

Rent

= 20000 p.m

Built area

= 10000sq ft

Rent per sq ft

= Rs30000/10000sq ft
= Rs3/sq ft/month

Cost of area

= 1200sq ft x Rs3
= Rs 3600

Per day charges

=Rs3600/26
= Rs138.46/day

Per cover

=Rs138.46/200 carton
= Rs0.692/ carton

Area of the Cover = 1.72sq ft


Cost of per cover = Rs12.11 x 1.72sq ft
= Rs20.82/ carton

Total cost of painting activity

Activity

Sub Activity

Painting

Cost of paint and thinner

Cost
Rs8.6

Labour cost

Rs1.6

Paint booth operation cost

Rs0.961

Power charges

Rs0.265

Area of painting booth

Rs0.692
Rs12.11/sq ft

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Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

Total
Cost of Per

Rs20.82/ carton

carton

5) Dispatching

1) Packing charges :
Packing material required: --Cost of wooden box = Rs 3000 (inclusive transportation cost, taxes)
Cost of plastic wire = Re 1.50/ carton
Cost of paper = Re1.00/ carton
Number of Covers packed per box = 200 carton
Rs3000 + (Re1.50 x 200) + (Re1.00 x 200) = Rs3500

2) Labour
People required = 3
5 boxes packed per day
Wages

= Rs200 + Rs150 + Rs150


= Rs500/day

Wages per box

= Rs500/5boxes
= Rs100/box

Total

=Rs 3500 + Rs100


= Rs 3600

Per Cover

= Rs3600/200 carton
=Rs18/ carton

Total of dispatching Activity

71

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

Activity

Sub Activity

Despatching

Packing charges

Cost
Rs3500

labour

Rs100
Rs3600/box

Total

Rs18/ carton
Cost Per

carton

COST PER UNIT OF THE PRODUCT

ACTIVITIES
1

Amount

COST/ carton

in Rs

Amt in Rs

PURCHASE OF RAW

95.017

MATERIALS
2

MANUFACTURING
Shearing

1.232

Circle cutting

0.2766

Deep drawing

0.9578

Trimming

0.639

Piercing

0.468
Total

3.5734

INSPECTION

0.0422

PAINTING

19.90

DESPATCHING

18.00
GRAND

TOTAL

72

136.68

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

FINDINGS
73

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

FINDINGS

1. SAI PACKING LTD, MYSORE are specialized in deep drawn components


that cater the electrical, elevator, home appliances automobile industry and the
defense.
2. SAI PACKING LTD, MYSORE follows traditional method of costing.
3. The product carton is over costed.
4. According to traditional costing the cost of the cover is Rs.143.50
5. According to Activity Based costing the cost of the cover is Rs136.68
6. According to costing followed by SAI PACKING LTD, MYSORE they first
identify the cost then they go for producing the product rather than identifying
the activities first.
7. Appropriate variable overheads are identified to individual products through
ABC.
8. All levels of activities in the manufacturing cost hierarchy viz unit level, batch
level, product level and facility level have been identified.
9. Cost drivers for the activities have been identified.
10. SAI PACKING LTD, MYSORE relates overheads to cost centers which are
not realistic to the behavior of costs.
11. To get a realistic analysis of cost behavior, the overheads have been properly
related to cost drivers.

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Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

SUGGESTIONS

75

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

SUGGESTIONS

1. SAI PACKING LTD, MYSORE should adopt Activity Based costing in

their organization.
2. As ABC integrates well with Six Sigma and continuous improvement

programs the company can achieve minimum rejection rate.


3. To arrive at the actual cost of the product, overheads should not be directly

assigned to the cost center which is basically done in traditional costing.


4. Instead of focusing more on cost reduction they should focus more on cost

control.
5. SAI PACKING LTD, MYSORE can adopt cost control strategy where in the

company can begin by evaluating non-labor expenses which can be controlled.


6. Labor and employment costs are a source of considerable expense and should

be constantly monitored.
7. If it is possible to amalgamate two jobs into one, make some jobs part time,

use temporary contract labor, outsourcing to specialists, consider if some other


choice of labor cost saving is available.
8. SAI PACKING LTD, MYSORE should follow an open style with clear and

concise objective for the successful implementation of ABC.


9. Organization-wide awareness should be extended to convince the participants

to change, as well as effecting the change.


10. Overheads are part of running a business but can be controlled. Everything

from cleaning materials to the cost of vehicle operation , machine


maintenance, consumable materials and staff employment costs can, and must
be kept as low as possible.

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Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

CONCLUSION

77

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

CONCLUSION

ABC utilizes the activity concept and by using the activities, ABC can successfully
link the product costs to production knowledge. How a product is produced, how
much time is needed to perform an activity and finally how much money is absorbed
by performing this task are answered by the help of ABC studies. This method is a
dynamic tool for continuous improvement. With ABC to its benefit, any enterprise
will have a built in competitive cost advantage and can continuously add value to
both its stakeholders and customers.

Therefore, Activity-Based Costing measures the costs and profits of an organization


based on the activities performed within that organization. By focusing on processes
that contribute to revenues and business operations, ABC can accurately determine
how each process relates back to specific products, customers, or services. This can
make a big difference after considering warehouse, sales, customer service,
administration and other costs that are often applied at a standard rate, if at all. With
ABC you can drill into profitability and performance by almost any factor you can
think of.

78

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

BIBLOGRAPHY

79

Activity Based Costing as a measure of improving the cost structure at SAI


PACKING LTD, MYSORE

BIBLOGRAPHY
Books

: 1) COST ACCOUNTING for BUSINESS


MANAGERS by Asish K Bhatacharyya.

2) COST ACCOUNTING by I M Pandey

Websites :

babasabpatilfreeppt.com

80