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.