لخّصلي

hi welcome to the ACCA f5

I'm Hafeez and I'm going to take you

through to the ACCA paper f5 let's start

in this session we are going to talk

about absorption costing and

activity-based costing absorption

costing and activity-based costing are

to cost accumulation methods cost

accumulation means whether we are

working for a production organization

manufacturing or we are working for a

service based organization we

manufacture goods and we produce

services so when a product or a service

is produced we need to know the value of

the product or a service meaning how

much money have we spent to produce this

product or how much money we have

incurred to generate the service first

method or cost accounting method is

absorption costing any product is made

up of three main components when I say

three main components

I'm sure you've got my idea already I'm

talking about a manufacturing physical

product for example a computer a TV a

chair a car etc any product is made up

of three basic components direct

materials direct labor and production

overheads I'm sure you have understood

this idea in your previous paper of

management accounting which was paper f2

so here is a little reminder that as per

absorption costing in order to calculate

full or total cost of production of one

unit we need to find out how much

material has been used in one unit how

much labor cost has been applied to one

unit and how much of production

overheads were charged to one unit of

it is not difficult to calculate the

cost of direct materials and direct

labor direct materials all you need to

know is couple of things number one you

need to know the usage of direct

materials meaning kilos meters litters

etc and secondly the price of those

meters liters and kilos so quantity

multiplied by price you will get the

cost of direct materials in one unit

direct labour is also very

straightforward to work out all you need

to know is that time how long did we

take to produce this product and what

was the rate per hour we are paying to

the workforce so the time multiplied by

the hourly rate we get the cost of

direct labor so in ACC exams it is very

very straightforward

when it comes to the production

overheads then we use two methods okay

one of the two first method you have

studied in paper f2 as I was talking

about which was absorption costing as

per absorption costing production

overheads are charged to the products to

the manufactured goods on the basis of

overhead absorption rate okay which is

the formula you can see here overhead

absorption rate is based upon this

formula which is budgeted overhead cost

for a period divided by budgeted level

of activity for a period now when we say

budgeted overhead cost

it simply means overheads are of various

types generally overheads are bills or

period costs okay for example rent rates

utilities repair and maintenance

depreciation supervision cost factory

rates or rent etc these are all some

heating lighting electricity these are

all overheads so right at the beginning

of the year

we work out the estimate of the

overheads for the whole year whole

period and then at the same time we work

out budgeted level of activity for a

whole period so in your previous paper

after you've seen it otherwise you can

see a number of type of activities can

be used to charge overheads or to

calculate overhead absorption rate most

popular are direct labor hours or

machine hours okay we can use either

number of labor hours as the budgeted

level of activity or we can use machine

hours as the budgeted level of activity

or we can use number of units as well if

you like so budgeted overhead is divided

by budgeted number of units okay now you

might have noticed from this formula of

the absorption costing overhead

absorption rate budgeted overhead is

divided by budgeted level of activity

this is a traditional system of costing

why traditional because you have applied

this in your real life as well many of

you might have applied this in real life

this is a system of sharing when we say

sharing it's like this if two or three

friends are living in a shared property

so the bills of that property divided by

two or three people and we can work out

the bills per person or rent of the

property divided by two or three people

living in that property we can share

that rent as well this is exactly what

I'm talking about relating to this

overhead absorption rate okay do friends

share a taxi or a cab from A to B so

whatever the fare works out divided by

two people and that simply overhead

absorption rate okay so this is the most

traditional technique accountants have

applied in absorption costing which is

let's share the overheads over the

volume of activity and as I said

depending upon the choice of the

accountants the volume of activity can

be number of machine hours number of

labor hours or number

of units or sometimes when the labor or

machine our detail is not known to us

okay what we can do is we can use the

percentage of sales revenue as well that

if product has got higher sales revenue

that should carry higher value of

overheads and if a product has a lower

sales revenue we can charge lower value

of overheads to the product as well so

again choice but remember remember in

one exam question we only apply one

level of activity not all of them at the

same time okay based upon this overhead

absorption rate we can calculate very

easily how much of overheads should be

charged to one unit of a one unit of B

one unit of C okay so here is a quick

reminder about absorption costing

absorption costing is a system of full

costing of a product and full costing

includes direct materials number one

direct labor number two and production

overheads production overheads can be

calculated by using overhead absorption

rate and then cost of a product is

calculated with the help of this cost

per unit we can work out selling price

as well

okay cost plus profit equals two selling

price and we can price our products so

generally the companies which have got

very little number of product lines one

two three single product lines or maybe

two or three companies feel comfortable

to apply absorption costing they're

quite okay to apply absorption costing

absorption costing method can work quite

well for small organizations small

organizations which have very limited

operations and the organizations which

do not have production complexity most

of the jobs are done by the human hands

or maybe a little equipment or tools are

used okay production is straightforward

it's been used for years and years and

years and still in application for more

than 85 percent of the companies in the

world

okay absorption costing is the most used

method of cost accounting okay now let's

have a look at this second

which is the activity-based costing okay

activity-based costing or a BC activity

first of all before I talk about what

activity-based costing is let's have a

look at why did we need activity-based

costing okay before actually I'll go

into much details and then question

solving and number crunching and

practice okay a little bit of idea

please remember any product is made up

of three components so here is the

absorption costing and activity-based

costing so any product is made up of

three components whether it is

absorption or ABC first component is

materials or direct materials second is

labor or direct labor if you like to

call it and thirdly production overheads

now here is before I start ABC under

absorption costing an ABC activity-based

costing both materials and labor are

calculated

likewise in a simple identical way there

is no difference in calculation between

absorption and ABC when it comes to the

cost of materials and labor in both

absorption and ABC materials quantity

times price labor time multiplied by the

rate okay when it comes to the

production overheads then both

techniques work in a simple different

way okay

then both techniques work in a different

way for example when it is absorption

costing then overheads are charged using

one overhead absorption rate

we use only one overhead absorption rate

the formula which I have shown you

budgeted overheads divided by budgeted

labor hours or budgeted overhead is

divided by budgeted number of units or

budgeted overhead is divided by budgeted

machine hours or labor hours whatever is

given in the question one overhead

absorption rate is used to charge

overheads to each product but when it

comes to the ABC activity-based costing

then we don't use a one overhead

absorption rate then production

overheads are charged to the products by

different method okay and this different

method we are going to talk about which

is based upon various activities as the

method name is activity-based costing

then we use a costing system which is

based upon activities the costing system

based upon activities so let's have a

look at the details of the

activity-based costing right so very

recently about 20-25 years ago the

accountants or the managers of the

companies they noticed that some time

absorption costing misleads the results

misleading results is simply this that

in a number of cases when we use one

overhead absorption rate for example

labor hours a number of people argue

what when you use the formula over

budgeted overhead is divided by budgeted

in labor hours what's the logic behind

it and a number of times we are confused

because we can't find any logic why not

simply because if you look at the

formula if I take you back to the

formula okay budgeted overheads divided

by budgeted level of activity overhead

is a sum of various indirect costs like

rent rate electricity power heating

lighting insurance maintenance cafeteria

and canteen safety and security at

what is the relationship between

overheads and the labor hours I mean to

say do we pay the rent

overhead based upon number of hours do

we spend money on cafeteria cost on the

basis of number of hours do we spend

money on CCTV cameras or factory

security on the basis of number of hours

do we spend the money on heating and

lighting on the basis of number of hours

and the answer is or insurances on the

basis of number of hours and the answer

is no actually we pay insurance for a

period we pay rent for a period we pay

for a number of other bills for a period

one month two months one year etc so a

number of people believe that there is

no direct relationship between the

overheads and the working hours and

sometimes when we apply this gas work

gas means that we are guessing there is

a relationship between overheads and the

number of labor hours or machine hours

when we apply this gas work a number of

times our cost is inappropriate or

misleading so when the organizations

were simple small and less competitive

less less competition in the society

then we used to get away with it we

could have applied absorption costing as

well because overheads were small

product lines were little so the method

was working somehow but over the last 25

years or so we noticed that as we are

entering the new world okay

many many companies or competitors are

in the market companies are producing

many many products there is a huge

production complexity and absorption

costing in some organizations wasn't

giving us the right value of cost so

then we started looking into the

activity-based costing so activity-based

costing was started when we felt that

there was higher level of production

complexity in the manufacturing process

meaning some of the production jobs are

done by the human hours labor hours some

of the jobs are gone

by the machine hours some of the jobs

are done by the robotics technology and

some jobs are even outsourced as well so

when we set up overhead absorption rate

question arises which hours shall we use

in this formula should we use labor

hours Oh No there are machine hours as

well

oh so shall we use machine hours I know

there are some robots lying in there as

well so they will get upset if we don't

use the robotic hours okay what about

the outsourcing so a number of times it

was misleading due to increased

production complexity second reason was

that increase proportion of overhead

cost okay as I said remember my word

guesswork so when we guess that there is

some sort of relationship between

overhead cost and the labor or machine

hours we are considering assuming that

because all the heads are small okay so

even if the guess is wrong my

calculation is not that much wrong as

per a study done by one of the

professional Institute's

a couple of years ago they identified

some of the statistics over the last 50

years that about 50 years ago production

was very simple production was very

small and the proportion of overhead

cost in one unit was approximately five

to six percent so if we were spending

$100 on a product only five or six

dollars were coming from the overheads

but recently in the last few years I'm

talking about 2000 onwards the

proportion of overhead cost in a product

has gone messily higher so if nowadays

an average company is spending $100 on a

product approximately 35% plus $35 or

more come from the overheads so in the

past many years ago if my calculation or

my guess was slightly wrong I was not

wrong

that much because overheads were very

small but nowadays if my guess is wrong

my cost will be utterly wrong and my

price may not be appropriate and I may

lose the market so I have got to be

slightly more accurate in my costing

okay and that was the reason

activity-based costing was starting to

develop okay

now let's have a look at how this system

works ABC analysis okay

best way to remember activity-based

costing is if you read the ABC the other

way around

it is a costing system which is based

upon activities it is a costing system

based upon activities activity-based

costing is not a system of totality

totality means under the absorption

costing we assume that all production

takes place under one roof that's why we

use one overhead absorption rate whether

labor hours or machine hours but we use

labor hours or machine hours of the

whole company okay right not one by one

activity but under the activity-based

costing we do not calculate the

overheads for the organization we cost

the overheads of each activity as a

separate organization so under the

activity-based costing each activity is

like a small organization in its own

right so it is activity-based costing so

overheads of each activity will be

calculated separately and then later on

we can merge them up together for a

product okay right in activity-based

costing here are some of the calculation

steps which generally examiner's are

interested about whether it's section a

or section B we are interested to find

out cost drivers for each cost pool cost

pool is the overhead cost of each

product okay so please remember I'm sure

you are familiar with the terminologies

but in case cost pool simply represents

overhead of each activity

okay so we need to calculate the cost

drivers for each activity we will

explain in a minute okay and secondly we

can be asked to calculate cost per unit

using activity-based approach okay

depending upon section a or section B

because in Section a examiner's cannot

ask everything in one question of two

marks so generally they may ask you

calculate the cost driver rate or they

may give us so many info so much of

information and they may ask us to link

this up to a product calculate the cost

per unit using ABC when plenty of

information is already sorted out okay

but a full system of activity-based

costing which generally comes up in

Section B which are longer questions ten

to fifteen marks and then we are asked

to discuss a number of steps or to

calculate a number of steps so here is a

full system of activity-based costing

within the organization activity-based

costing starts with breaking down the

production process into various

activities okay we break down the whole

production process into small small

small activities or small functions or

if you fancy call them mini departments

okay now there are a number of

activities which we can imagine okay so

very quickly I can write down here for

you okay just a few activities as an

example so organization can be divided

into a number of activities for example

a resource acquisition

okay for example purchasing department

comes under the resource acquisition in

order to produce any physical product we

need raw materials and in order to buy

raw materials we have a separate

purchasing department okay so for

example purchasing or in manufacturing

you can imagine cutting okay chopping

different elements of a product wood

plastic metal steel etc cutting

Department or it can be finishing or it

can be assembly okay

or it could be

we're housing okay packaging quality

control so we can divide the production

process into a number of many

departments many functions or activities

and activity-based costing is a costing

system of each activity individually

okay

overhead of each activity will be

calculated itself nothing to do with

other activities okay so one activity is

considered as a small organization in

its own right okay I just listed a few

activities for a large organization

okay multi-billion dollar worth of

organization there can be 50 activities

40 activities hundreds of activities

okay just a few in exam you may only be

given two or maximum three activities

not much because of the time constraints

okay now let's proceed further so first

of all we break down the production

process into various activities the

product passes through number two we

determine cost driver for each activity

we determine cost driver for each

activity now cost a driver is simply a

reason or a factor or a base which

generates the overhead cost so it is any

factor within the activity which can

trigger the overhead cost meaning which

can increase the overhead cost of that

activity and that factor can decrease

the overhead cost of that activity okay

here is a couple of examples and we will

move on for example if you look at a

number of activity purchasing the first

one okay you would appreciate if we have

a purchasing department okay where there

is a purchasing manager there are

purchasing assistants and so many people

working in the purchasing department

they have only maybe many many functions

but main responsibility is to

materials so when we talking about

purchasing department okay

purchasing department is responsible to

purchase raw materials when they

purchase raw materials there are a

number of administrative jobs they have

to do for example now first of all they

need to find out the right supplier

searching around once they find the

suppliers they need to wet these

suppliers they need to shortlist the

suppliers they need to contact the

suppliers whether they are provided of

the right material or not then they

start negotiating with the suppliers

once they choose one supplier then they

place the purchase order how purchase

order is placed I don't know I'm not the

purchasing expert probably over the

phone or by sending a purchase order by

post or by dropping an email to the

supplier that I need these type of

materials these price that's the dates

and that's the delivery point okay and

other terms and conditions and then

purchasing department receives the

delivery shipment and then loading of

loading and the material goes into the

warehouse etc okay after inspecting the

material if it's right or something then

it goes into the warehouse now these are

so many administrative jobs purchasing

department has to do question arises is

this if there are a couple of strategies

in front of the purchasing department

okay what can be an appropriate cost

driver for the purchasing department so

my idea is for example purchasing

department needs to buy 1,000 kilos okay

I'm just assuming that purchasing

department is looking to buy 1,000 kilos

one strategy is they can buy all 1,000

kilos in one purchase order one po1

purchase order they can buy all 1,000

kilos in one go meaning contact the

supplier once

exchange communication once receive the

delivery or shipment once do the

inspection once and transfer them to the

warehouse once ok or a second strategy

can be instead of buying all 1,000 kilos

in one purchase orders a number of

people do not buy in bulk they may buy

1000 kilos in 10 purchase orders of 100

kilos 100 kilos 100 kilos again I'm not

asking about I'm not talking about

whether buying in bulk one purchase

order is good and buying in can purchase

orders is bad I'm not judging okay which

one is better for the company my idea is

to develop a cost driver for the

purchasing overheads okay if we will buy

1000 kilos in 10 purchase orders do we

not need to contact the supplier 10

times do we not to exchange the

communication or information 10 times do

we not need to raise invoices 10 times

or get the invoices 10 times and do we

not to get the material delivery 10

times inspection 10 times and

transferring to the warehouse 10 times

my question is this what do you think

buying in one purchase order involves a

lot of hassle or buying in 10 purchase

orders increases the administrative job

what do you think I'm waiting for your

answers alright okay yes you are

shouting back at me I'll come on it is a

lot more easier to purchase all

materials in one go and if we will place

10 purchase orders we will have to go

through the same exercise 10 times okay

telephone cost 10 times shipment cost 10

times inspection 10 times etc so

administrative hassle or administrative

job increases more if we place more

purchase orders so here can I not define

purchase orders as an appropriate cost

driver this is how management and the

accountants they sit down together and

they develop the cost drivers that which

factor is actually changing the cost

overhead cost so if we can control the

cost driver somehow we can control the

cost meaning if we change the number of

purchase orders the overhead cost will

change okay more the purchase orders

more the overhead cost less the purchase

orders less the overhead cost okay I can

give you a number of examples but I

think now you've got my point so when

you will be reading the books things

will start getting better okay so let's

move on here are some examples given

okay for some cost pools or activities

for material handling number of orders

can be used okay material ordering

material handling quantity of material

can be used production scheduling number

of production runs or sometimes instead

of runs we may be given number of

batches okay again depending upon

whether examiner wants to call it number

of production runs or number of

production batches or some time examiner

can give us another synonym of the same

run or batches which can be setups

depending upon the information provided

course dispatching dispatching can be

based upon number of deliveries more

number of dispatches more number of

deliveries etc okay once we know and one

good thing is that you are clearly given

in each question okay what are the cost

driver so you don't need to imagine an

exam question about these cost drivers

this was just additional information if

you need to discuss or explain things so

at least you know what I'm talking about

okay but for calculation point of view

you don't need to worry about if you

will be given the production process

broken down into activities activities

will be given to you cost drivers will

be given to you in the exams okay what

you need to do is now here from step

number three okay here is calculate the

cost driver rate for each activity okay

now cost driver rate is number of

formula we developed for activity-based

costing it is very very similar to

overhead absorption rate the only

difference is one overhead absorption

rate is calculated for one organization

whereas number of course driver rates

can be calculated based upon number of

activities so if we have five activities

within organization we will calculate

five cost driver rates if we have twenty

activities of a production process we

will be calculating twenty cost driver

rates okay so for each activity we will

calculate a separate cost driver rate so

formula of the cost driver rate can be

like this it's very similar to overhead

absorption rate okay only difference is

many many overhead absorption rates we

need to develop relating to each

activity so here is cost the driver rate

formula okay for each activity overhead

cost

now please remember overhead cost of

each activity is always given for a

period of one month one quarter or

generally one year okay so overhead cost

of each activity for the period in

question divided by total number of

drivers selected for a period meaning to

say I'm just assuming if for example I

was talking about the purchasing

department so the cost driver rate for a

purchasing department will be overhead

cost of the purchasing activity divided

by total number of purchase orders for

the period okay so for each activity we

need to select one driver for purchasing

it can be number of purchase orders for

material handling it could be quantity

of materials for ordering it can be

number of orders etc okay so overhead

cost of purchasing activity divided by

total number of drivers which are per

purchase orders for this activity one

thing some time examiner's confuse in

the exams which is not too difficult

which is that they don't give us the

drivers for a period they may give us

purchase orders for each product

separately okay or they may give us

purchase orders for each batch

separately you must make sure one thing

before you set up this formula if the

purchase orders are given for each

product if the drivers are given for

each product please convert calculate

the total number of purchase orders or

total number of inspections or total

number of runs or total number of the

driver for a period

okay and then afterwards you can

calculate this rate make sure that has

to be total number of the driver for a

period because the overhead cost is

given for the period once we have

calculated this now we can link this

rate up with every product okay all the

basis of consumption or usage meaning if

any product has more purchase orders it

will carry more share of the overhead if

any product has less number of drivers

it will carry less share of the overhead

so link the cost driver rates of each

activity to each product on consumption

or usage basis so more driver

consumption in a product more overhead

cost in a product okay so this was the

basic idea of the activity-based costing

now let's do little practice okay before

we do the practice again as I was

explaining before cost per unit will

always be based upon three elements

direct materials direct labor based upon

the same method okay there is no

difference between absorption and

activity-based when it comes to the

overhead cost then yes we can be

choosing activity-based or absorption

costing but we will see it in a question

okay here we go right you can see a very

typical section B type question on

absorption and activity-based costing

okay right hence how limited has a

single production process for which the

following overhead costs have been

estimated for the period ending 31st of

December 2014

so following overhead costs following

are the overhead costs which have been

estimated for the period okay not for

individual product but for the whole

period the givenness material receives

an inspection power cost and material

handling cost afterwards three products

XY and z are produced by workers who

perform a number

of operations on the material blanks

using hand-held electrically powered

drills the workers are paid four dollars

per hour so this is something an

important information

why because I think when I will

calculate the cost of labour I may need

this hourly rate they get paid four

dollars per hour okay

the following budgeted information has

been obtained for the period ending 31st

of December so some more details about

the products okay there are three

products XY and Z and they given us the

details production quantity in units how

many units we are going to produce

batches of material how many batches of

materials we will get for XY and Z and

then they given us data per product unit

okay

meaning now onwards any information

below in this table relates to one unit

of X one unit of Y and 1 unit of Z okay

meaning how much direct material direct

material square meters in one XYZ direct

material cost in one XYZ in dollars and

then direct labor in minutes and number

of power drill operations in one XY and

said at present the company absorbs all

overhead cost by the way before I move

on I think with the help of this

information I can easily calculate cost

of direct materials and direct labor

whether it's absorption or ABC it will

remain the same labor information is

given material information is given as

soon as I will start calculating you

will see ok that I will use the same

values for absorption and ABC when it

comes to materials and labor cost okay

right at present the company absorbs all

overhead costs into the products using

labor hours absorption costing

so this is the current system of costing

an activity-based costing investigation

has revealed that the cost drivers for

the overhead cost

are as follows so now we are given for

each overhead activity their own

selected cost drivers okay meaning for

material receipt and inspection we will

use the driver as number of batches for

process power we will use number of

power drill operations and for material

handling we will use quantity of

materials handled so for absorption

costing only one overhead absorption

rate but for activity-based costing

three cost driver rates because there

are three activities okay

so please keep on watching it now here

are the requirements okay so it is a

Section B question longer question okay

which is I suppose this should be around

15 marks minimum okay requirement

calculate the product cost per unit one

unit cost for each XYZ detailing the

unit cost of each cost element number

one using the existing method for the

absorption of overhead cost and number

two an approach which recognizes the

cost drivers revealed in the ABC

investigation

okay so requirement one is absorption

requirement two is ABC let's set up the

answer plans and then we will pick up

the information from this example hence

our limited and then we will be dealing

it one by one so here we go

and requirement one is absorption

costing cost per unit and because there

are three products so I think it would

be much more convenient if I can set up

three columns one for each product okay

XY and Z so for example this is for X

that's for Y and that's for say and

numbers are in dollars so I can just

list down dollar signs once so that I

don't need to repeat this in the exams

now there are three cost elements one is

direct materials second is direct labor

[Music]

and third is production overheads

okay production overheads now here is

for the activity-based costing

requirement - so this is the answer plan

for the activity-based costing ABC cost

per unit okay

again ABC is making the same thing XY

and Z so there are three products x y

and z again numbers are in dollars okay

and again there are three elements

materials labor and overheads

okay right first of all let's deal with

materials labor and then overheads okay

here is the information about materials

so if I just remove all other details

and focus on what is the first cost

which is materials I'm given here the

data per product unit here is the direct

material cost information there are two

informations given direct material

square meters and secondly direct

material cost now please tell me for one

unit of X what is the cost of materials

in one X I wait for 10 seconds what is

the cost of direct materials for one

unit of X oh okay what about some of the

people all right okay now I've got I

heard a couple of answers from you some

people are saying the cost of materials

in one X is five dollars and some people

are saying the cost of materials in one

X is 20 dollars

let's analyze both the answers those

people who are calculating twenty

dollars they are assuming something

assuming is this they are multiplying 4

by 5 to get 20 what they are assuming is

this they are assuming that Examiners

data is not complete and they are adding

some of the information themselves okay

this is what they are adding direct

material cost in dollars was it like

this

if I was given information like this

then four times five was perfectly

justified I was not given direct

material cost in dollars per square

meter if I was given per square meter

than five per square meter times by four

meters 20 but I was not given my brain

assumes something so one thing please in

exams especially for ACCA f5 okay try

not to apply assumptions okay without

assumptions you can pass it quite

comfortably without even any assumptions

you can pass it quite comfortably okay

so try to try not to apply it

assumptions imagine details are correct

okay I was already given direct material

cost in one X in dollars that one X

costs five dollars in materials one y

three dollars in materials and 1z six

dollars in materials of five three and

six okay understood here is the direct

labor now I can highlight information

about directly but one information was

here workers are paid four dollars per

hour and direct labor time was given in

minutes

so you've got to be careful here we are

not given the time of XY and Z in hours

we are given time of XYZ in minutes 24

40 and 60 so it's not much difficult

rate is four dollars per hour

we just need for X it will be x by 24

over 60 because there are 60 minutes in

an hour for y it will be 40 over 60 and

for Z it will be 60 over 60 okay so here

is my calculator four times 24 over 60

labor cost in 1x is

164 times 40/60 which is 267

approximately and 4 times 60 over 60 is

for labor cost is calculated ok now we

are looking at the production overheads

and remember under absorption costing we

apply overhead absorption rate 1

overhead absorption rate and in the

question it was saying based upon labor

hours ok so first of all here is the

formula for the production overhead

absorption rate over HAP's option rate

equals to total budgeted overhead cost

for 2014 year given in period is 2014

divided by total budgeted because boy

budget because overhead absorption rate

is established at the beginning of the

year when the budgets are there only we

don't have actual results so budgeted

information is used so total budgeted

overhead cost for the 2014 and total

budgeted labor hours just need to double

check labor or machine hours yes using

labor hours

for 2014

okay now let's pick the numbers one by

one first of all then top or numerator

budgeted overhead cost overhead cost is

given here okay in the very first

paragraph we just need to add them

together

15600 nineteen and a half thousand and

thirteen six fifty in total forty eight

thousand seven fifty okay in total forty

eight thousand seven hundred and fifty

dollars okay remember in absorption

costing we believe in total results for

the organization not individual

activities okay

second is the labor hours we are not

given labor hours for the period 2014 we

are only given time for one x one y one

Z and here we go if we are given time of

1 X 1 y 1 Z we can easily determine

total time for XY and Z all products for

2014 and labor hours will be done so

here we go 24 40 and 60 labor hours will

be 24 40 and 60 for each product

multiplied by two thousand fifteen

hundred and eight hundred and we will

get total hours budgeted hours labor

hours for the 2014 ok

so 24 by the way because the time is

given in minutes so please don't

remember don't forget to divide it by 60

because it's not in hours it's in

minutes and we need in hours okay so

that's Y divided by 60 so 24 into 2,000

divided by 60 that comes to 800

forty times by fifteen hundred divided

by 60 which is 1000 and then 60 into 800

divided by sixty sometimes I become

stupid like I mean I become stupid like

this

I know 60 times eight hundred over sixty

will give me eight hundred anyway and in

total two thousand six hundred so use

calculators whenever you really need to

use otherwise some simple calculations

you can do it manually but just in case

make sure don't make a mistake okay now

here is the both informations sorted out

so Oh a R will be like this forty-eight

thousand seven hundred and fifty total

overheads got it from the question okay

divided by two thousand six hundred

hours and here is the overhead

absorption rate per hour for one hour so

forty eight 750 divided by two thousand

six hundred it gives me eighteen point

seven five per hour

18.75 for one labor-hour and now i can

link this rate because this is not for

one unit of X Y Z this is eighteen point

seven seven five per hour meaning when

one x one y or one Z remains in

processing for one full hour overhead

cost is eighteen point seven five but if

any product remains in processing for

less than one hour overhead cost will be

less than eighteen point seven five and

if any product remains in processing for

more than one hour

overhead cost will be more than eighteen

point seven five so here is final

linking up the production overheads okay

which is eighteen point seven five times

twenty four forty and sixty divided by

sixty just like labor okay

right so here we go 1875 into 24 over 60

which is 7.5 second one is 1875 into 40

over 60 which is twelve fifty and

finally because Z is processed for one

full hour so overhead costs will be full

eighteen point seven five and that gives

us full or total cost per unit for each

product XY and set let's add them

together for each product five plus one

sixty plus 750 1410 okay III remember

these answers but I'm just doing it the

way you will be doing it in exams so

that's why I'm using calculator right in

front of you just like a human effort in

actual exam sometimes I make mistakes

maybe purposely sometimes okay but this

is how we do it okay I'm not just

copying and pasting

I'm a dancers okay so please do it the

way we are doing it just like in actual

exams so three plus two sixty seven plus

twelve fifty eighteen point one seven

and finally 2875 that's full cost of one

x one y one Z using absorption costing

okay now let's do the activity-based

costing here is the ABC cost per unit

full cost per unit again please remember

as far as materials and labor are

concerned that will just be copy and

paste or five three and six no problem

with that labor cost copy and paste one

sixty two sixty seven and four and when

it comes to the overheads instead of one

overhead absorption rate we will

calculate overhead for each activities

separately and remember there were three

activities given to us material receipt

and inspection

material handling and third sorry

secondly power

and thirdly material handling okay now

what we do is first of all we develop

cost driver rates okay now very quickly

let's have a look at the cost drivers

we are told right at the end of the

question that there are three cost

drivers one for each activity number of

batches for the material receipts number

of power drill operations for the

process power and material handling for

the quantity of material in square

meters is it okay now let's do it one by

one first of all material receipt and

inspection material receipt inspection

cost is fifteen thousand six hundred

okay divided by number of batches of

materials so material receipt and

inspection cost divided by number of

batches of material that will give us

the cost driver rate and here are the

number of batches of materials ten five

and 16

okay so cost driver rate if I show use

on a separate page that will help you to

understand okay in a better way so here

our cost driver rates okay first of all

material receipt

and inspection okay cost is fifteen six

hundred divided by number of batches

examiner told us number of that is to be

used okay so which are ten five and

sixteen okay or if you fancy add them up

which is thirty one and that works out

the material receipt an inspection cost

per batch so fifteen 600 divided by

thirty one we get approximately you can

see on the screen five oh three point

two three

500 3.23 per batch this is the first

cost driver rate okay five hundred and

three dollars twenty three cents then

one batch is received and inspected okay

but we are not in just interested to

know cost of material receipt per batch

we are interested to know how much of

this goes into one x1 y1 z1 it cost of

this material receipt and inspection in

one x1 y1 that which is very simple all

we need to do is this that we need 10

batches for X in a year and there are

two thousand units of X produced out of

10 batches okay

so all we need to do is take this rate

here okay

five hundred and three point two three

and for the product X multiplied by ten

divided by two thousand units and we

will get the received and inspection

cost of 1x okay so five oh three point

two three times by ten five oh three

point two three times by ten divided by

two thousand which gives me point zero

three or I can double check this one

okay five hundred and three twenty three

times by ten divided by two thousand

which is 2.5 - okay sorry that was a

little mistake

two point five to approximately receipt

an instruction overhead in 1x now

exactly the same way for the product Y

okay how many batches are used for Y 5

so x five batches divided by 50

hundred units okay so idea is use the

total drivers as a denominator first and

then multiply back by the same number of

driver for each product consumption

basis okay so let me repeat it in order

to calculate the cost driver rate total

overhead cost of one activity divided by

total of the driver selected for that

activity that is cost driver rate then

link that rate to each product how

multiply that back by the same

denominator for each product well kept

meaning to say the same individual

denominators represent consumption of a

receipt and inspection cost for one x1y1

said okay so use them in total as a

denominator and then use them in the

next step as a multiplier for each

product one by one okay so second one is

five oh three point two three times by

five divided by 1500 which comes to one

point six eight approximately and

thirdly 503 twenty three into number of

batches are sixteen into sixteen divided

by eight hundred which is ten point oh

six

that's the material receipt and

inspection overhead in one x1 y1 z DG

notice something before I look into

power and material handling remember how

I was defining and developing the cost

drivers cost drivers are the bases or

factors which become the reason to

generate overhead which trigger the

overhead which control the overhead cost

meaning more the driver number more the

overhead cost less the driver number

less the overhead cost so if management

wants to control or reduce the receipt

and inspection cost they must need to

reduce the number of batches by putting

more units in one batch and if they will

get less number of batches they will

have less value of overhead in each

product okay second is process power

process power cost is 19 and a half

thousand that and that should be based

upon number of power drill operations

and here are power drill operations okay

the only thing is these are power drill

operations per unit because this data

all this data below is per unit so six

drill operations for 1 X 3 drill

operations for one Y and to drill

operations for one Z and if we multiply

them by two thousand fifteen hundred and

800 respectively we will get total

number of drill operations so let's do

the same thing again

first of all cost driver rate process

power

okay which is nineteen and a half

thousand dollars divided by total number

of powered rail operations and for each

product we are given only individual

power drill operation 6 3 + 2 XY and Z

one by one there are 2,000 units of X so

12,000 operations in a year times by 15

1500 units for Y so four and a half

thousand units re operations for y and x

by eight hundred units we will get 1600

operations for Z and if we add them

together twelve thousand plus four and a

half thousand plus sixteen hundred its

eighteen thousand one hundred process

power nineteen and a half thousand

divided by eighteen thousand one hundred

operations we will get power cost per

operation so here we go

nineteen and a half thousand divided by

that which is one point zero eight

approximately per operation that when

one drill operation is performed power

cost is one point zero eight

now let's link this rate to one X ones

that Y and one Z okay so here we go

process power one point zero eight x

remember the individual power operation

six three and two so for the product X

it will be x by six for the y times by 3

and 4 z times by two so six times by one

point zero eight four six forty eight I

think

okay I suppose then three times by that

which is 324 and 216 and did you get the

same logic here as well

same logic of cost drivers inherent in

the activity-based costing that more

number of drivers means more cost lower

the number of drivers means lower the

cost and if management is interested to

control the cost they need to

investigate how can they control the

drill operations of each product last

one is material handling same principle

material handling cost is 13,000 650 so

first of all the driver rate or overhead

absorption rate for the material

handling and it is based upon quantity

of material in square meters handled and

quantity of materials is given here for

meters six meters and three meters but

that's again per unit for meters in 1 X

6 meters in one Y and three meters in

one Z whereas 13650 is given for the

whole 2014 okay so here is the cost

driver rate for material handling cost

in exam completely your choice you can

show cost driver rates separately or you

can just show in the main answer plan as

well if you have plenty of space okay

because you'll normally write in pens

okay so you have you can accommodate

this information within the answer plan

as well but here I need to explain and

I'm writing slightly bigger as well so

you can see it that's why I'm showing it

separately one by one material handling

cosplays 13,000 650 divided by number of

materials handled for the year so for X

Y & Z we are given the materials for six

and three these are square meters for

square meters for 1 X 6 square meters

for one Y and three square meters for

one Z and there are two thousand units

of X in a year 1500 units of Y in a year

and 800 units for Z in a year and that

will give me total number of materials

to be handled in here 2014 8,000 square

meters 9000 square meters at 2400 in

total 19400 square meters

that's the total of the cost drivers so

here we go 13,000 650 divided by 19 400

that comes 2.70

approx

70 cents approximately per square meter

okay

per square meter and here is linking

this answer to the product x y&z so zero

point seven times by remember how many

square meters in 1 X 4 6 & 3

respectively okay so four times 72 84

times by 70 cents six times by 70 cents

for 20 and three times 70 cents is 210

and did you see the same principle more

the materials handled more the overhead

cost less the materials handled and less

the overhead cost and that's building up

a concept among us that it is a more

appropriate or more fairer method of

costing okay not everything is by labor

hours or machine hours but based upon

individual consumption of the cost

drivers once this is done all overheads

have been evaluated now we just need to

add materials with the labor and then

individual overheads and we will get

total cost per unit or full cost per

unit which we can quickly do it here 5

plus 160 plus 250 2 plus 6 48 plus 2.8

that gives us 18 point 4 0 second one is

3 plus 2 67 plus 168 324 and for 2014 79

and thirdly 4 plus 6 10 then plus 1006

then to 16 and then to 10 24 32

right that gives us the activity-based

cost per unit full cost per unit okay

now you can compare the numbers will be

slightly different of course because

it's a different method of costing as

per absorption costing we had fourteen

ten eighteen seventeen eight twenty

eight seventy five and using the ABC

numbers are slightly different okay and

that gives management another thinking

point based upon this cost as per ABC

how they can improve the product

profitability or product competitiveness

somewhere where the cost is greater they

need to reduce the cost by controlling

the drivers and wherever the cost is low

they need to decrease the selling price

to bring more profit margin or improve

the sales demand okay so make sure you

can revise this session okay you can

watch it again in a game and every step

you can watch me again so that you know

you can be more confident about this

absorption and ABC okay so thank you

very much of your time and patience in

listening to me I will see you with some

more work very soon okay so please make

sure you remind yourself with all the

steps we have covered today what again

okay and I'll be waiting for your

feedback as well okay any problems give

us a shout just make sure read the study

material okay steady text and notes

watch this video make sure try to do the

practice try to do this example on your

own pace so that you can feel whether

you have learned every step in

absorption and ABC or you need to do

more work okay

all the very best take care good bye