The key characteristics of the activity base costing theory

It is a method where the allotment of the costs is done for the merchandises and services. This method was established in order to work out the job associated with the traditional costs direction method. The chief advantage for utilizing this method is that it is a device for control and planning. Traditional method where unable to work the information service cost, production and besides fails to supply necessary information and advice for the operation section of the company or the house. Activity base bing theory allows the house to have the merchandises and services more accurately and decently. The cardinal features of the Activity base bing theory is that it helps to cut down the high operating expense costs per unit. The lone disadvantage it has is the designation of the procedures and the activities which have to be allocated decently and this is sometimes really feverish and takes tonss of clip.

Solution to inquiry 1: Analysis and advice of the job

First of all we will simplify this instance survey of 3 pools of cost into two homogenous cost pools i.e. one cost pools will consists of non-production volume related costs and other will consists of production volume related costs. This can be done because the use or outgo sum for the non-production volume related cost pools like receiving/purchasing, apparatuss and technology are the same and the outgo sum for the production volume related cost pools like machining, power, care and stuff handling are the same. Furthermore the cylinder fabrication company produces two merchandises one is standard merchandise with high volume and the other is specialised merchandise with low volume.

In this instance analyze the pool for non-production volume cost will dwell of set ups and technology support and the pool for production volume cost consists of machines and stuff handling.

Harmonizing to the information provided by Davina we have the followers:

Budgeted overhead costs per month

In & A ; lb ;



Setup and technology support


Materials managing


Entire operating expenses


Direct labor hours


Entire fabrication cost excepting direct stuffs


Distribution of the cost pools:

Activity pool

monthly costs in ( & A ; lb ; )

Measure of activity

Non-production volume cost ( NPVC )

& A ; lb ; 200,200

Number of purchase orders

Production volume cost ( PVC )

& A ; lb ; 399,100

Number of direct labor hours

Entire operating expense cost

& A ; lb ; 599,300

Now we calculate the Activity base costs for Cylinder fabrication company.

First we calculate the Non-production volume cost

= monthly costs of NPVC/total purchase order

= & A ; lb ; 200,200/460 = & A ; lb ; 435.22 purchase per order

Now we calculate the Product volume cost

= monthly costs of PVC/total direct labor hours

= & A ; lb ; 399,100/4000 = & A ; lb ; 99.775 per direct labor hours

Now we do the computation for each rate:

Machine hr operating expense rate =total for machines overhead cost/total

machine hr

= & A ; lb ; 399100/6500

= & A ; lb ; 61.4 ( entire for machines and

Machine managing i.e. & A ; lb ; 279500+ & A ; lb ; 119600= & A ; lb ; 399100 )

Setup overhead rate= entire for apparatus overhead cost/total figure of


= & A ; lb ; 200,200/280 = & A ; lb ; 715

Now we come to the concluding phase of ABC process:

Unit of measurement costs for the company:

Different costs

Standard merchandise in ( & A ; lb ; )

Specialized merchandise in ( & A ; lb ; )

Direct labor hours*



Machine overheads*



Setups overheads*



Direct labor hours*= entire figure direct labour hours/labour hours for

standard merchandise

Machine overheads*= entire machine hr overhead*machine hr for

the standard product/ specialised merchandise

Setups overheads*= number setups hr overhead* figure of apparatuss for

the standard product/ specialised merchandise

Cost traced to merchandises for cylinder fabrication company for two merchandises


Activity rate multiplied by measure of activity step in ( & A ; lb ; )

Entire monthly cost in ( & A ; lb ; )

Entire unit cost in ( & A ; lb ; )

Non merchandise volume cost ( Standard merchandise )




Non merchandise volume cost ( Specialized merchandise )




merchandise volume cost ( Standard merchandise )




merchandise volume cost ( Specialized merchandise )




Direct labor ( Standard merchandise )




Direct labor ( Specialized merchandise )




Product wise cost:


Entire cost in ( & A ; lb ; )

Entire Unit cost in ( & A ; lb ; )

( Standard merchandise )










( Specialized merchandise )










Here we are given entire cost per labour hr i.e. & A ; lb ; 192.325 and the budgeted labour hr are 4000.

Entire operating expense for the Standard merchandise for the cost traced is & A ; lb ; 319072.7 ( & A ; lb ; 69635.2+ & A ; lb ; 249437.5 ) and the unit cost is & A ; lb ; 127.615. For the Specialized merchandise for cost traced is & A ; lb ; 280228.5 ( & A ; lb ; 130566+ & A ; lb ; 149662.5 ) and the unit cost is & A ; lb ; 186.819. Further direct labor cost for standard merchandise is & A ; lb ; 32695250 and for specialized merchandise is & A ; lb ; 32974516.88 and for the unit direct labor cost is & A ; lb ; 13078.1 and & A ; lb ; 21796.19225 for criterion and specialized merchandise severally. The chief advantage for Davina to exchange to the machine hours is to cut down the operating expense load for her company.

Solution to inquiry 2: Analysis depended on Activity based system

The chief construct of utilizing ABC ( Activity based costing ) is to bring forth, design and administer the merchandises and services require by the assorted activities to be performed. Due to this piece executing this activities it requires to capital to utilize and buy things. After this the activities of the company ‘s are identified and the cost is traced to this activities. By making this Activity base costing is use to work out the job that are cause by traditional cost method and stock list rating method.

In this illustration of Davina ‘s cylinder fabrication company which produces two types of merchandises that is standard and specialized. From the computation done in solution to inquiry 1, it can be seen that the cost of bring forthing specialized merchandise is less than the cost of bring forthing standard merchandise. The decrease in the cost is 0.12 % ( & A ; lb ; 39805.82 ) . Besides the entire unit cost for specialized merchandise is more than standard merchandise, but specialised merchandise produces 300 figure of shop orders compared to 160 of standard merchandise. This means that unit cost of standard merchandise is & A ; lb ; 27.84 and its green goodss 160 shop orders where unit cost of specialized merchandise is & A ; lb ; 87.044 and its green goodss 300 orders of shops which is twice every bit much as standard merchandise and that to at the 1500 labor hours which is 1000 labor hours less than standard merchandise. Further the unit cost for machine operating expenses for the standard merchandise is & A ; lb ; 214900 which is more than unit cost of specialized merchandise, & A ; lb ; 184200. This addition is about 16.66 % , which could be said that Davina ‘s company is doing a loss of 16.66 % by non concentrating more in fixing specialized merchandise. The apparatus operating expense for specialized merchandise is more than twice than comparison to the standard merchandise. But it besides setups more than twice the figure of apparatuss than the standard merchandise. Although the entire unit cost for Specialized merchandise is 66.46 % more than standard merchandise but it generates 353.50 % more net income than standard merchandise. ( & A ; lb ; 39805.82- & A ; lb ; 8777.29625/ & A ; lb ; 8777.29625 )

Solution to the inquiry 3: Decision and recommendation

As reference before that the Activity base bing method is much easy and advanced than traditional cost method and stock list rating method. Davina should implement this method because Activity base bing method contains all the four of import stairss which are either overlooked or non taken into consideration by the other methods. Those four stairss are as follows:

Identifying the chief activities of the company in which it is engaged.

Determining the drivers of primary and secondary activities.

Uniting company ‘s activities into the homogeneous pools of cost

Choosing the steps for activity to stand for each pool.

Due to this grounds Davina should follow this method of Activity base costing and besides should engage the staff who knows this method and can implement it for her Cylinder fabrication company and could assist her to derive net income.

The greatest fright that Davina has is that its gross revenues mark are met but her net income border is diminishing. This is because of improper allotment of machine hours and labour hours. As in solution to oppugn 1 and 2, we have obtain and warrant that cost spend in bring forthing standard merchandise is less but its net income border is besides less whereas the entire cost incurred in bring forthing specialized merchandise is less and its net income border is more. But the drawback of bring forthing specialized merchandise more is that its entire unit cost is more than standard merchandise. So Davina should apportion machine hours and labour hours in such a manner that specialised merchandise is manufactured more by the company in order to bring forth more net income and increase the value of the house along with this Davina should seek to cut down the cost of bring forthing standard merchandise in order to increase net income border by implementing proper machine and labour hours such that the figure of apparatuss and figure of shop orders are increase consequently. Besides this the budgeted overhead load is & A ; lb ; 149.825/labour hr which is rather more than the existent cost for spend on bring forthing specialised merchandise which is merely & amp ; lb ; 113.33/ labour hr. Hence in order to acquire the company out of jobs and do to do the operations of the company smooth and steady, Davina should get down fabrication specialized merchandise wherein she could bring forth more net income. Besides if she spends a spot more say for illustration & A ; lb ; 80/labour hr behind standard merchandise and increase its productiveness and quality than she might be able to increase her net income in standard merchandise every bit good. Thus for Davina there are assorted options available but the harmonizing to consequences obtain in solution to oppugn 1 and 2, the best 1 would be to get down bring forthing more specialized merchandise as it has more net income border than standard merchandise and use of resources is besides low-cost to Davina ‘s cylinder fabrication company.


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