Product Profitability – ABM/ABC – Part III

Step-7: Calculate rate per unit of cost driver

 

The rate per unit of cost driver can be calculated using the following formula:

Cost of Activities (step 5)/ Volume of activities (Step 6)

 

 

Using the above formula the rate per unit of cost driver for each of the identified operating activities is given in the table below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sl.

Name of operating activities

Cost the activities (Step 5)

Budgeted total qty of cost driver/month

Rate per unit of Cost Driver

a

b

c

a

B

c

1 In-bound logistics

10,060

9,925

9,951

10,000

   1.06/lb

 0.99/lb

     1.00/lb

2 Machining

213,510

214,147

21,4225

240 MH

889.63/MH

892.28/MH

  892.60/MH

3 Quality Control

32,079

32,038

32,077

50 QCT

641.58/QCT

640.76/QCT

 641.54/QCT

4 Packaging

7,353

7,368

7,360

1200 LH

       6.13/LH

       6.13/LH

        6.13/LH

5 Out-bound logistics

12,583

12,488

12,508

25000 Pcs

       0.50/Pc

       0.50/Pc

        0.50/Pc

6 Selling & distribution

31,562

31,401

31,223

36,000 MRH

   0.88/MRH

   0.87/MRH

    0.87/MRH

7 Marketing

22,853

22,633

22,656

3,920,000 USD

    0.01/USD

    0.01/USD

     0.01/USD

a)         Direct allocation    b)  Step-down allocation     c) Reciprocal allocation method

 

Step-8: Allocate costs of operating activities to products

 

In an ABC system cost of operating activities will finally be allocated to the cost objects (here the products) using the following formula:

= Rate per unit of cost driver (calculated in Step 7) times Quantity of cost drivers consumed by the the each of the products (identified in Step 6)

 

 

 

The table below shows the allocated amount of cost of operating activities (under all the three options of support costs allocation method) to Product A and Product B using the above formula:

 

Name of operating activities

Costs allocated to Product A

Costs allocated to Product B

A

b

c

a

B

c

In-bound logistics

     6,036

     5,955

       5,971

         4,024

         3,970

        3,980

Machining

   88,963

   89,228

     89,260

   124,548

    124,919

   124,965

Quality Control

   16,040

   16,019

     16,039

      16,040

      16,019

     16,039

Packaging

     4,289

     4,298

      4,293

        3,064

         3,070

        3,067

Out-bound logistics

     7,550

     7,493

       7,505

         5,033

         4,995

        5,003

Selling & distribution

   17,534

   17,445

     17,346

      14,028

      13,956

     13,877

Marketing

   11,660

   11,547

     11,559

      11,193

      11,086

     11,097

Total

152,071

151,985

  151,973

    177,929

    178,015

   178,027

a)      Direct allocation    b)  Step-down allocation     c) Reciprocal allocation method

 

As it is seen above (in step 7) that rate per unit of cost driver has been calculated based on budgeted consumption of costs drivers, the actual consumption of cost drivers may be different from that.

And also in most cases, to estimate the rate per unit of cost drivers, budgeted amount of costs of activities are allocated to cost objects.  Therefore, actual overhead costs may be higher or less than the allocated amount, which is called under-application or over-application of overhead costs. Then under/over application of overhead costs are then charged to/ adjusted with cost (or inventory of goods) at the time of preparing P&L statement.

PRODUCT P&L:

Basis

Product A

Product B

a

b

c

a

b

c

Sales Revenue

  2,000,000

  2,000,000

2,000,000

1,920,000

1,920,000

1,920,000

Less: Cost of goods sold
Raw material Direct tracing

       40,000

       40,000

     40,000

     60,000

     60,000

     60,000

Packing material Direct tracing

       11,250

       11,250

    11,250

     13,750

     13,750

     13,750

Wages (direct portion) Direct tracing

1100

          1,100

       1,100

           900

          900

           900

Manufacturing overhead allocated Allocated  in step-8

     122,877

     122,993

   123,068

   152,708

   152,973

  153,053

Under/ (over) applied of manufacturing overhead N/A                   –                  –                 –                 –                 –                –
COGS

     175,227

     175,343

   175,418

   227,358

   227,623

   227,703

Gross Profit

  1,824,773

 1,824,657

1,824,582

1,692,642

1,692,377

1,692,297

Less: Marketing selling & distribution
physician pack Direct tracing

6000

          6,000

       6,000

       4,000

      4,000

       4,000

Sales incentive Direct tracing

4000

          4,000

       4,000

       6,000

      6,000

       6,000

Indirect portion allocated Allocated

       29,194

       28,992

    28,905

    25,221

    25,042

     24,974

Under/ (over) applied N/A                   –                  –                –                –                 –                –
Total mkt., sell. & dist.

       39,194

       38,992

     38,905

    35,221

     35,042

     34,974

Operating Profit

  1,785,579

  1,785,665

1,785,677

1,657,421

1,657,335

1,657,323

a)      Direct allocation    b)  Step-down allocation     c) Reciprocal allocation method

 

 

 

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