Product Profitability – ABM/ABC – Part II

Step-5: Allocate/assign support activities costs to operating activities

 

The support activity costs need to be allocated to operating activities. And later the total cost of operating activities) will be allocated to products (cost objects). Any of the following three methods can be used practically for allocating support activity costs. Here we are showing all the three methods.

 

 

a)               Direct allocation method

 

In the direct method allocation, each support activity’s costs are directly allocated to operating activities based on the support received by the operating activities; without considering the services received by other support activities (e.g. on the basis of time a particular support activity invests in each of operating activities). In the excel sheet calculation is given based on the data given (Annex-1). The allocated costs are given in the table below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating activities

Total

In-bound logistics Machining Quality Control Packaging Out-bound logistics Selling & distribution Markt.
Cost of activities before any inter-department costs allocations

         7,595

194,114

         26,721

 6,753

      10,179

25,331

      20,750

  

291,443

Allocated support costs
Allocating cost of plant administration

            720

14,405

           2,881

 288

            864

 –

               –

19,158

Allocating cost of Acct & IT     1,707

        4,878

       2,439

            122

     1,463

        2,439

      1,951

     15,000

Allocating cost of HR

         38

            114

            38

            190

          76

        3,792

         152

        4,399

    2,465

      19,396

       5,358

            600

     2,404

        6,231

      2,103

     38,557

 

 10,060

   213,510

    32,079

         7,353

  12,583

      31,562

   22,853

   330,000

 

 

a)               Step-down allocation method

Table 6

Operating activities

Total

In-bound logistics Machining Quality Control Packaging Out-bound logistics Selling & distribution Markt.
Cost of activities before any inter-department costs allocations

       7,595

   194,114

   26,721

       6,753

    10,179

      25,331

   20,750

   291,443

Allocated support costs
Allocating cost of Acct & IT

       1,511

        4,317

     2,158

          108

      1,295

        2,158

     1,727

     13,273

Allocating cost of HR

            39

            117

           39

          196

            78

        3,911

        156

        4,537

Allocating cost of plant administration

          780

      15,599

     3,120

           312

          936

               –

             –

     20,746

       2,330

      20,033

     5,317

           615

      2,309

        6,070

     1,883

     38,557

Total cost

       9,925

   214,147

   32,038

       7,368

    12,488

      31,401

   22,633

   330,000

 

 

 

 

 

 

 

 

b)               Reciprocal allocation method

Table 7


Operating activities

Total

In-bound logistics Machining Quality Control Packaging Out-bound logistics Selling & distribution Marketing
Cost of activities before any inter-department costs allocations

         7,595

194,114

         26,721

 6,753

      10,179

25,331

      20,750

  

291,443

Allocated support costs

         2,356       20,111            5,356              607         2,329         5,892         1,906      38,557

Total cost

   9,951

    214,225

    32,077

         7,360

  12,508

      31,223

   22,656

   330,000

 

Details of the allocation of support activity costs to operating costs under reciprocal allocation method is given in a excel sheet (Annex-1)

 

Step-6: Identify appropriate cost drivers (activity drivers)for allocating cost of operating activities to products (the cost objects) and quantity of cost drivers

 

We have seen in the Step 5 that all the costs of support activities have been allocated/ assigned to operating activities.  So, now we need to allocate the cost of operating activities only to the identified products. In our study we have only seven operating activities, and therefore, we need 7 (seven) cost drivers (which will be determined considering cause-effect relationship as practically as possible).  The appropriate cost drivers for allocating cost of seven operating activities along with the budgeted (in our study assumed) quantity cost drivers   are mentioned below:

 

Sl.

Name of operating activities

Name of cost drivers

Budgeted total qty of cost driver/month

Break ups of budgeted cost drivers

For product A

For product B

1 In-bound logistics Quantity of material purchased (lbs)

10,000

6,000

4,000

2 Machining Machine Hour (MH)

240 MH

100 MH

140 MH

3 Quality Control No. of times quality check is done (QCT)

50 QCT

25 QCT

25 QCT

4 Packaging Labor Hour (LH)

1200 LH

700 LH

500 LH

5 Out-bound logistics Quantity of product sold

25000 Pcs

15,000 Pcs

10,000 Pcs

6 Selling & distribution MR-Work Hour (MRH)*

36,000 MRH

20,000 MRH

16,000 MRH

7 Marketing Value of the products sold (USD)

3,920,000 USD

2,000,000 USD

1,920,000 USD

*Number of Medical Representative times Number of working days  times Working Hour per days

In next article we will calculate rates etc.

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