Conventional and Activity Based Costing in Accounting and Financial Management

This document discusses the conventional and activity based costing methods in accounting and financial management. It explains the differences in cost per unit calculation using both methods and analyzes the reasons behind these differences. The document also explores activity based management and its implications.

AF102 – Introduction to
Accounting and Financial
Management Part II

TABLE OF CONTENTS
Conventional product costing system..........................................................................................3
Activity based costing (ABC)......................................................................................................3
A) Defining volume based driver.................................................................................................4
B) Calculating the cost per unit for each product using conventional method............................4
C) Calculating the cost per unit for each product using ABC method........................................5
D) Assessing reasons behind the occurrence of difference in per unit cost as per both the
methods........................................................................................................................................5
E) Activity based management....................................................................................................5
REFERENCES..............................................................................................................................6

Conventional product costing system
Manufacturing overhead costs allocated on the basis of machine hours per unit. Total
Three products X, Y, Z
Basis Product X Product Y Product Z
Direct Material 16*600= 9600 10*1300= 13000 20*7000= 140000
Direct Labour 600*0.5*7= 2100 1300*1.5*7= 13650 7000*1*7= 49000
Production
Overhead
600*1*25= 15000 1300*1*25= 32500 7000*2*25= 350000
Total 26700 59150 539000
Activity based costing (ABC)
Overhead cost pools Percentage Amount
Costs relating to set ups 20% 79500
Costs relating to machinery 18% 71550
Costs relating to material
handling
25% 99375
Costs relating to inspection 37% 147075
Total 100% 397500
The total overhead costs are 397500.
Overhead cost allocation: -
Overhe
ad cost
pools
Cost
drivers
Amou
nt
Product X Product Y Product Z Total
Costs
relating
to set
ups
Number
of set
ups
79500 60/590*79500
= 8085
110/590*79500
= 14822
420/590*79500=
56593
7950
0
Costs
relating
to
machine
ry
Machine
hours
71550 600/15900*71
550= 2700
1300/15900*71
550= 5850
14000/15900*71
550= 63000
7155
0

Costs
relating
to
material
handlin
g
Number
of
moveme
nt of
material
s
99375 10/115*99375
= 8641
25/115*99375=
21603
80/115*99375=
69131
9937
5
Costs
relating
to
inspecti
on
Number
of
inspecti
ons
14707
5
110/900*1470
75= 17976
170/900*14707
5= 27781
620/900*147075
= 101318
1470
75
Total 37402 70056 290042 3975
00
Basis Product X Product Y Product Z
Direct Material 16*600= 9600 10*1300= 13000 20*7000= 140000
Direct Labour 600*0.5*7= 2100 1300*1.5*7= 13650 7000*1*7= 49000
Production
Overhead
37402 70056 290042
Total 49102 96706 479042
A) Defining volume based driver
It here is referred to the machine hour’s rate given per hour of the products volume that is
produced. In other words, volume based drivers are highly related to output and facilitates
allocation of overheads in the best possible way (Banker and et.al., 2018). Hence, by using such
driver’s management accountant can assign overhead cost to the product and thereby would
become able to take appropriate decision about profitability.
B) Calculating the cost per unit for each product using conventional method
Product X= 26700/600= 44.5
Product Y= 59150/1300= 45.5

Product Z= 539000/ 7000= 77
C) Calculating the cost per unit for each product using ABC method
Product X= 49102/600= 81.8
Product Y= 96706/1300= 74.38
Product Z= 479042/ 7000= 68.43
D) Assessing reasons behind the occurrence of difference in per unit cost as per both the methods
 In the conventional method the overhead allocation was done on the basis of machine
hour rate per unit. Whereas on the contrary in case of activity based costing the overheads
are separately allocable based on the cost driver’s data that has been provided.
 In case of product Z the cost per unit has decreased significantly because earlier they had
double the machine hours used and higher the volume of production, which increased its
per unit cost. But on the other hand in the ABC method it has suitable allocation based on
the cost drivers that are applicable to the various products.
 The systematic overhead distribution on the basis of particular activity pool and the cost
drivers have helped in generating viable cost per unit of the products.
E) Activity based management
It is the method to know the various activities that are performed by the business and also
evaluate the cost per unit based on the activity based costing method. In this the distribution of
the overheads among the various products are done on the basis of cost drivers (Quesado and
Silva, 2021). The cost driver have been developed on the basis of its applicability for particular
activity. The shall help in the continuous improvement of the business as this is suitable method
of allocation and shall be providing the rightful results in terms of the cost per unit. It shall also
ensure that the business decisions based on these cost are effectively taken shaping the future
prospects of the company.

REFERENCES
Books and Journals
Banker, R. D. and et.al., 2018. Cost management research. Journal of Management Accounting
Research. 30(3). pp.187-209.
Quesado, P. and Silva, R., 2021. Activity-Based Costing (ABC) and Its Implication for Open
Innovation. Journal of Open Innovation: Technology, Market, and Complexity. 7(1). p.41.