Activity Based Costing

Q.1. ABC Ltd. is a multiproduct company, manufacturing three products A, B and C. The budgeted
costs and production for the year ending 31st March are as follows:
A B C
Production quantity (Units) 4,000 3,000 1,600
Resources per Unit:
- Direct Materials (Kg.) 4 6 3
- Direct Labour (Minutes) 30 45 60
The budgeted direct labour rate was ` 10 per hour, and the budgeted material cost was ` 2 per kg.
Production overheads were budgeted at ` 99,450 and were absorbed to products using the direct
labour hour rate. ABC Ltd. followed the Absorption Costing System.
ABC Ltd. is now considering to adopt an Activity Based Costing system. The following
additional information is made available for this purpose.
1. Budgeted overheads were analysed into the following:
(`)
Material handling 29,100
Storage costs 31,200
Electricity 39,150
2. The cost drivers identified were as follows:
Material handling Weight of material handled
Storage costs Number of batches of material
Electricity Number of Machine operations
3. Data on Cost Drivers was as follows:
A B C
For complete production:
Batches of material 10 5 15
Per unit of production:
Number of Machine operations 6 3 2
You are requested to:
1. PREPARE a statement for management showing the unit costs and total costs of each product
using the absorption costing method.
2. PREPARE a statement for management showing the product costs of each product using the
ABC approach.
3. STATE what are the reasons for the different product costs under the two approaches?

Q.2. Woolmark Ltd. manufactures three types of products namely P, Q and R. The data relating to a
period are as under:

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 Particulars P Q R
Machine hours per unit 10 18 14
Direct Labour hours per unit 4 12 8
Direct Material per unit (`) 90 80 120
Production (units) 3,000 5,000 20,000
Currently the company uses traditional costing method and absorbs all production overheads on
the basis of machine hours. The machine hour rate of overheads is `6 per hour. Direct labour hour
rate is ` 20 per hour.
The company proposes to use activity based costing system and the activity analysis is as under:
Particulars P Q R
Batch size (units) 150 500 1,000
Number of purchase orders per batch 3 10 8
Number of inspections per batch 5 4 3
The total production overheads are analysed as under:
Machine set up costs 20%
Machine operation costs. 30%
Inspection costs. 40%
Material procurement related costs 10%
Required
(i) CALCULATE the cost per unit of each product using traditional method of absorbing all
production overheads on the basis of machine hours.
(ii) CALCULATE the cost per unit of each product using activity based costing principles.

Q.3. MST Limited has collected the following data for its two activities. It calculates activity cost rates
based on cost driver capacity.
Activity Cost Driver Capacity Cost
Power Kilowatt hours 50,000 kilowatt hours ` 2,00,000
Quality Inspections Number of Inspections 10,000 Inspections ` 3,00,000
The company makes three products M, S and T. For the year ended March 31st, the following
consumption of cost drivers was reported:
Product Kilowatt hours Quality Inspections
M 10,000 3,500
S 20,000 2,500
T 15,000 3,000
Required:
(i) COMPUTE the costs allocated to each product from each activity.
(ii) CALCULATE the cost of unused capacity for each activity.
(iii) DISCUSS the factors the management considers in choosing a capacity level to compute the
budgeted fixed overhead cost rate.

Q.4. ABC Ltd. Manufactures two types of machinery equipment Y and Z and applies/absorbs
overheads on the basis of direct-labour hours. The budgeted overheads and direct-labour hours for
the month of December are ` 12,42,500 and 20,000 hours respectively. The information about
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 Company's products is as follows:
Equipment Equipment
Y Z
Budgeted Production volume 2,500 units 3,125 units
Direct material cost ` 300 per unit ` 450 per unit
Direct labour cost
Y : 3 hours @ `150 per hour
Z : 4 hours @ ` 150 per hour ` 450 ` 600
ABC Ltd.'s overheads of ` 12,42,500 can be identified with three major activities:
Order Processing (`2,10,000), machine processing (`8,75,000), and product inspection
(`1,57,500). These activities are driven by number of orders processed, machine hours worked,
and inspection hours, respectively. The data relevant to these activities is as follows:
Orders processed Machine hours Inspection
worked hours
Y 350 23,000 4,000
Z 250 27,000 11,000
Total 600 50,000 15,000
Required:
(i) Assuming use of direct-labour hours to absorb/apply overheads to production, COMPUTE the
unit manufacturing cost of the equipment Y and Z, if the budgeted manufacturing volume is
attained.
(ii) Assuming use of activity-based costing, COMPUTE the unit manufacturing costs of the
equipment Y and Z, if the budgeted manufacturing volume is achieved.
(iii) ABC Ltd.'s selling prices are based heavily on cost. By using direct-labour hours as an
application base, CALCULATE the amount of cost distortion (under-costed or over-costed)
for each equipment.

Q.5. 'Humara - Apna' bank offers three products, viz., deposits, Loans and Credit Cards. The bank has
selected 4 activities for a detailed budgeting exercise, following activity based costing methods.
The bank wants to know the product wise total cost per unit for the selected activities, so that
prices may be fixed accordingly.
The following information is made available to formulate the budget:
Activity Present Cost (`) Estimation for the budget period
ATM Services:
(a) Machine Maintenance 4,00,000 All fixed, no change.
(b) Rents 2,00,000 Fully fixed, no change.
(c) Currency Replenishment Cost 1,00,000 Expected to double during budget
period.
7,00,000 (This activity is driven by no. of ATM
transactions)
Computer Processing 5,00,000 Half this amount is fixed and no change
is expected.
The variable portion is expected to
increase to three times the current level.

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 (This activity is driven by the number of
computer transactions)
Issuing Statements 18,00,000 Presently, 3 lakh statements are made.
In the budget period, 5 lakh statements
are expected.
For every increase of one lakh
statement, one lakh rupees is the
budgeted increase.
(This activity is driven by the number of
statements)
Computer Inquiries 2,00,000 Estimated to increase by 80% during the
budget period.
(This activity is driven by telephone
minutes)
The activity drivers and their budgeted quantifies are given below:
Activity Drivers Deposits Loans Credit Cards
No. of ATM Transactions 1,50,000 - 50,000
No. of Computer Processing Transactions 15,00,000 2,00,000 3,00,000
No. of Statements to be issued 3,50,000 50,000 1,00,000
Telephone Minutes 3,60,000 1,80,000 1,80,000
The bank budgets a volume of 58,600 deposit accounts, 13,000 loan accounts, and 14,000 Credit
Card Accounts.
Required:
(i) CALCULATE the budgeted rate for each activity.
(ii) PREPARE the budgeted cost statement activity wise.
(iii) COMPUTE the budgeted product cost per account for each product using (i) and (ii) above.

Q.6. RST Limited specializes in the distribution of pharmaceutical products. It buys from the
pharmaceutical companies and resells to each of the three different markets.
(i) General Supermarket Chains
(ii) Drugstore Chains
(iii) Chemist Shops
The following data for the month of April in respect of RST Limited has been reported:
General Supermarket Drugstore Chemist
Chains (`) Chains (`) Shops (`)
Average revenue per delivery 84,975 28,875 5,445
Average cost of goods sold per delivery 82,500 27,500 4,950
Number of deliveries 330 825 2,750
In the past, RST Limited has used gross margin percentage to evaluate the relative profitability of
its distribution channels.
The company plans to use activity-based costing for analysing the profitability of its distribution
channels.
The Activity analysis of RST Limited is as under:

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 Activity Area Cost Driver
Customer purchase order processing Purchase orders by customers
Line-item ordering Line-items per purchase order
Store delivery Store deliveries
Cartons dispatched to stores Cartons dispatched to a store per delivery
Shelf-stocking at customer store Hours of shelf-stocking
The April month's operating costs (other than cost of goods sold) of RST Limited are ` 8,27,970.
These operating costs are assigned to five activity areas. The cost in each area and the quantity of
the cost allocation basis used in that area for the month of April are as follows:
Activity Area Total costs (`) Total Units of Cost
Allocation Base
Customer purchase order processing 2,20,000 5,500 orders
Line-item ordering 1,75,560 58,520 line items
Store delivery 1,95,250 3,905 store deliveries
Cartons dispatched store 2,09,000 2,09,000 cartons
Shelf-stocking at customer store 28,160 1,760 hours
Other data for the month of April include the following:
General Supermarket Drugstore Chemist
Chains Chains Shops

Total number of orders 385 990 4,125

Average number of line items per 14 12 10
order
Total number of store deliveries 330 825 2,750
Average number of cartons shipped 300 80 16
per store delivery
Average number of hours of shelf- 3 0.6 0.1
stocking per store delivery
Required:
(i) COMPUTE gross-margin percentage for each of its three distribution channels and compute
RST Limited's operating income.
(ii) COMPUTE the rate per unit of the cost-allocation base for each of the five activity areas.
(iii) COMPUTE the operating income of each distribution channel using the activity-based costing
information. Comment on the results. What new insights are available with the activity-based
cost information?
(iv) DESCRIBE four challenges one would face in assigning the total operating costs of ` 8,27,970
to five activity areas.
Q.7. Family Store wants information about the profitability of individual product lines: Soft drinks,
Fresh produce and Packaged food. Family store provides the following data for the current year
for each product line:
Soft drinks Fresh produce Packaged food
Revenues ` 39,67,500 ` 1,05,03,000 ` 60,49,500
Cost of goods sold ` 30,00,000 ` 75,00,000 ` 45,00,000
Cost of bottles returned ` 60,000 `0 `0

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 Number of purchase orders placed 360 840 360
Number of deliveries received 300 2,190 660
Hours of shelf-stocking time 540 5,400 2,700
Items sold 1,26,000 11,04,000 3,06,000
Family store also provides the following information for the current year:
Activity Description of activity Total Cost Cost-allocation base
Bottles returns Returning of empty bottles ` 60,000 Direct tracing to soft
drink line
Ordering Placing of orders for ` 7,80,000 1,560 purchase orders
purchases
Delivery Physical delivery and receipt ` 12,60,000 3,150 deliveries
of goods
Shelf stocking Stocking of goods on store ` 8,64,000 8,640 hours of shelf-
shelves and on-going stocking time
restocking
Customer Support Assistance provided to ` 15,36,000 15,36,000 Items sold
customers including check-
out
Required:
(i) Family store currently allocates support cost (all cost other than cost of goods sold) to product
lines on the basis of cost of goods sold of each product line. CALCULATE the operating
income and operating income as a % of revenues for each product line.
(ii) If Family Store allocates support costs (all costs other than cost of goods sold) to product lines
using and activity-based costing system, CALCULATE the operating income and operating
income as a % of revenues for each product line.
Q.8. Alpha Limited has decided to analyse the profitability of its five new customers. It buys bottled
water at ` 90 per case and sells to retail customers at a list price of ` 108 per case. The data
pertaining to five customers are:
Customers
A B C D E
Cases sold 4,680 19,688 1,36,800 71,550 8,775
Listed Selling Price ` 108 ` 108 ` 108 ` 108 ` 108
Actual Selling Price ` 108 `106.20 ` 99 ` 104.40 ` 97.20
Number of Purchase orders 15 25 30 25 30
Number of Customer visits 2 3 6 2 3
Number of deliveries 10 30 60 40 20
Kilometers travelled per delivery 20 6 5 10 30
Number of expedited deliveries 0 0 0 0 1
Its five activities and their cost drivers are:
Activity Cost Driver Rate
Order taking ` 750 per purchase order
Customer visits ` 600 per customer visit
Deliveries ` 5.75 per delivery Km travelled

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 Product handling ` 3.75 per case sold
Expedited deliveries ` 2,250 per expedited delivery
Required:
(i) COMPUTE the customer-level operating income of each of five retail customers now being
examined (A, B, C, D and E). Comment on the results.
(ii) STATE what insights are gained by reporting both the list selling price and the actual selling
price for each customer.

Q.9. BABYSOFT is a global brand created by Bio-organic Ltd. The company manufactures three
ranges of beauty soaps i.e. BABYSOFT- Gold, BABYSOFT-Pearl, and BABYSOFT- Diamond.
The budgeted costs and production for the month of December are as follows:
BABYSOFT- Gold BABYSOFT- Pearl BABYSOFT- Pearl
Production 4,000 3,000 2,000
of soaps
(Units)
Resources Qty Rate Qty Rate Qty Rate
per Unit:
Essential 60 ml ` 200 / 100 55 ml ` 300 / 100 65 ml ` 300 / 100
Oils ml m ml
Cocoa 20 g ` 200 / 100 20 g ` 200 / 100 20 g ` 200 / 100
Butter g g g
Filtered 30 ml ` 15 / 100 30 ml ` 15 / 100 30 ml ` 200 / 100
Water ml ml g
Chemicals 10 g ` 15 / 100 12 g ` 50 / 100 15 g ` 60 / 100
ml g g
Direct 30 minutes ` 10 / hour 40 minutes ` 10 / hour 60 minutes ` 10 / hour
Labour
Bio-organic Ltd. followed an Absorption Costing System and absorbed its production overheads,
to its products using direct labour hour rate, which were budgeted at ` 1,98,000.
Now, Bio-organic Ltd. is considering adopting an Activity Based Costing system. For this,
additional information regarding budgeted overheads and their cost drivers is provided below:
Particular (`) Cost drivers
Forklifting cost 58,000 Weight of material lifted
Supervising cost 60,000 Direct labour hours
Utilities 80,000 Number of Machine operations
The number of machine operations per unit of production are 5, 5, and 6 for BABYSOFT- Gold,
BABYSOFT- Pearl, and BABYSOFT- Diamond respectively.
(Consider (i) Mass of 1 litre of Essential Oils and Filtered Water equivalent to 0.8 kg and 1 kg
respectively (ii) Mass of output produced is equivalent to the mass of input materials taken
together.)
You are requested to:
(i) PREPARE a statement showing the unit costs and total costs of each product using the
absorption costing method.
(ii) PREPARE a statement showing the product costs of each product using the ABC approach.
(iii) STATE what are the reasons for the different product costs under the two approaches

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Q.10. AML Ltd. is engaged in production of three types of ice-cream products Coco, Strawberry and
Vanilla. The company presently sells 50,000 units of Coco @ ` 25 per unit, Strawberry 20,000 @
` 20 per unit and Vanilla 60,000 units @` 15 per unit. The demand is sensitive to selling price and
it has been observed that every reduction of ` 1 per unit in selling price, increases the demand for
each product by 10% to the previous level. The company has the production capacity of 60,500
units of Coco, 24,200 units of Strawberry and 72,600 units of Vanilla. The company marks up
25% on cost of the product.
The Company management decides to apply ABC analysis. For this purpose it identifies tour
activities and the rates as follows :
Activity Cost Rate
Ordering ` 800 per purchase order
Delivery ` 700 per delivery
Shelf stocking ` 199 per hour
Customer support and assistance ` 1.10 per unit sold.
The other relevant information for the products are as follows:
Coco Strawberry Vanilla
Direct Material per unit 8 6 5
Direct Labour per unit 5 4 3
No. of purchase orders 35 30 15
No. of deliveries 112 66 48
Shelf stocking hours 130 150 160
Under the traditional costing system, store support costs are charged @ 30% of prime cost. In
ABC these costs are coming under customer support and assistance.
Required:
(i) Calculate target cost for each product after a reduction of selling price required to achieve the
sales equal to the production capacity.
(ii) Calculate the total cost and unit cost of each product at the maximum level using traditional
costing.
(iii) Calculate the total cost and unit cost of each product at the maximum level using activity
based costing.
(iv) Compare the cost of each product calculated in (i) and (ii) with (iii) and comment on it.
[Ans:(i)18.40, 14.40, 10.40,(ii) unit cost –16.90, 13.00, 10.40),(iii)Total: 9,85,320, 3,68,670, 7,83,100;
Unit cost:16.29,15.23, 10.17(iv)(i) – (iii): 2.11,: -0.83, 0.23,(ii) – (iii) 0.61,-2.23, 0.23]

Q.11. A Drug Store is presently selling three types of drugs namely 'Drug A', "Drug B' and 'Drug C'.
Due to some constraints, it has decided to go for only one product line of drugs. It has provided
the following data for year 2020- 21 for each product line:

Drugs Types
A B C
Revenues (in `) 74,50,000 1,11,75,000 1,86,25,000
Cost of goods sold (in `) 41,44,500 68,16,750 1,20,63,750
Number of purchase orders placed (in nos.) 560 810 630
Number of deliveries received 950 1,000 850
Hours of shelf-stocking time 900 1,250 2,350
Units sold (in Nos.) 1,75,200 1,50,300 1,44,500
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 Following additional information is also provided:
Activity Description of activity Total Cost Cost-allocation base
Drug Drug Licence fee 5,00,000 To be distributed in ratio
Licence fee 2:3:5 between A, B and C
Ordering Placing of orders for purchases 8,30,000 2,000 purchase orders
Delivery Physical delivery and receipt 18,20,000 2,800 deliveries
of foods
Shelf Stocking of goods 32,40,000 4,500 hours of shelf-
stocking stocking time
Customer Assistance provided to 28,20,000 4,70,000 units sold
Support customers
You are required to:
(i) Calculate the operating income and operating income as a percentage (%) of revenue of each
product line if:
(a) All the support costs (Other than cost of goods sold) are allocated in the ratio of cost of
goods sold.
(b) All the support costs (Other than cost of goods sold) are allocated using activity-based
costing system.
(ii) Give your opinion about choosing the product line on the basis of operating income as a
percentage (%) of revenue of each product line under both the situations as above.
[Ans:(i)(a) A: 16,47,700, B: 16,32,090, C: 17,35,210; A: 22.12%, B:14.60%, C: 9.32%;
(b) A: 6,56,400, B: 14,20,300, C: 29,38,300; A: 8.81%, B:12.71%, C: 15.78%;]

Q.12. DEF Bank operated for years under the assumption that profitability can be increased by
increasing Rupee volumes. But that has not been the case. Cost Analysis has revealed the
following:
Activity Activity cost (`) Activity Driver Activity
capacity
Providing ATM service 1,00,000 No. of transactions 2,00,000
Computer processing 10,00,000 No. of transactions 25,00,000
Issuing Statements 8,00,000 No. of statements 5,00,000
Customer inquiries 3,60,000 Telephone minutes 6,00,000
The following annual information on three products was also made available:
Checking Personal Gold Visa
Accounts Loans
Units of product 30,000 5,000 10,000
ATM transactions 1,80,000 0 20,000
Computer transactions 20,00,000 2,00,000 3,00,000
Number of statements 3,00,000 50,000 1,50,000
Telephone minutes 3,50,000 90,000 1,60,000
Required:
(i) Calculate rates for each activity.
(ii) Using the rates computed in requirement (i), calculate the cost of each product.
[Ans:(i) `0.50, `0.40, `1.60, `0.60; (ii) `52.67, ` 42.80, `46.60]

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Q.13. MK Ltd. manufactures four products, namely A, B, C and D using the same plant and process.
The following information relates to a production period:
Product A B C D
Output in Units 720 600 480 504
The four products are similar and are usually produced in production runs of 24 units and sold in
batches of 12 units. The total overheads incurred by the company for the period are as follows:

Machine operation and maintenance cost 63,000

Setup costs 20,000
Store receiving 15,000
Inspection 10,000
Material handling and dispatch 2,592
During the period the following cost drivers are to be used for the overhead cost:
Cost Cost Driver
Setup cost No. of production runs
Store receiving Requisitions raised
Inspection No. of production runs
Material handling and dispatch Orders executed
It is also determined that:
 Machine operation and maintenance cost should be apportioned between setup cost, store
receiving and inspection activity in the ratio 4:3:2.
 Number of requisition raised on store is 50 for each product and the No. of orders executed
is 192, each order being for a batch of 12 units of a product.
Calculate the total overhead cost per unit of each product using activity based costing after finding
activity wise overheads allocated to each product.
[Ans: `44.875, `47.375, `51.125, `50.232]

Q.14. PCP Limited belongs to the apparel industry. It specializes in the distribution of fashionable
garments. It buys from the industry and resells the same to the following two different
supermarkets:
(i) Supermarket A dealing in Adults' garments (Age group 15 - 30)
(ii) Supermarket B dealing in Kids' garments (Age group 5 - 10)
The following data for the month of April in respect of PCP Limited has been reported:
Supermarket A (`) Supermarket B (`)
Average revenue per delivery 1,69,950 57,750
Average cost of goods sold 1,65,000 55,000
per delivery
Number of deliveries 660 1,650
In the past, PCP Limited has used gross margin percentage to evaluate the relative profitability of
its supermarket segments.
The company plans to use activity-based costing for analysing the profitability of its supermarket
segments.
The April month's operating costs (other than cost of goods sold) of PCP Limited are ` 16,55,995.
These operating costs are assigned to five activity areas. The cost in each area and Activity
analysis including cost driver for the month of April are as follows:
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 Activity Area Total costs (`) Cost Driver
Store delivery 3,90,500 Store deliveries
Cartons dispatched to store 4,15,250 Cartons dispatched to a store per delivery
Shelf-stocking at customer store 64,845 Hours of shelf-stocking
Line-item ordering 3,45,400
Customer purchase order processing 4,40,000
Other data for the month of April include the following:
Supermarket A (`) Supermarket B (`)
Total number of store deliveries 1,100 2,805
Average number of cartons shipped per store delivery 250 50
Average number of hours of shelf-stocking per store 6 1.5
delivery
Average number of line items per order 14 12
Total number of orders 770 1,980
Required:
(i) Compute gross-margin percentage for each of its supermarket segments and compute PCP
Limited's operating income.
(ii) Compute the operating income of each supermarket segments using the activity-based costing
information.
[Ans: (i) 2.91%, 4.76%, 3.76%; `16,55,995 (ii) `26,11,400, `35,37,105]

Q.15. PQR Pens Ltd. manufactures two products - Gel Pen and Ball Pen. It furnishes the following data
for the year 2020:
Product Annul Output Total Machine Total Number of Total Number
(Units) Hours Purchase orders of set-ups
Gel Pen 5,500 24,000 240 30
Ball Pen 24,000 54,000 448 56
The annual overheads are as under:
`
Volume related activity costs 4,75,020
Set up related costs 5,79,988
Purchase related costs 5,04,992
Calculate the overhead cost per unit of each Product - Gel Pen and Ball Pen on the basis of:
(i) Traditional method of charging overheads
(ii) Activity based costing method and
(iii) Find out the difference in cost per unit between both the methods.
[(i) `87.27, `45 (ii) `95.39, `43.13 (iii) -8.12, +1.87]

Q.16. ABC Ltd. manufactures three products X, Y and Z using the same plant and resources. It has
given the following information for the year ended on 31st March, 2020:
X Y Z
Production Quantity (units) 1200 1440 1968
Cost per unit:
Direct Material (`) 90 84 176
Direct Labour (`) 18 20 30

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 Budgeted direct labour rate was ` 4 per hour and the production overheads, shown in table below,
were absorbed to products using direct labour hour rate. Company followed Absorption Costing
Method. However, the company is now considering adopting Activity Based Costing Method:
Budgeted Cost Driver Remarks
Overheads (`)
Material 50,000 No. of orders No. of orders was 25 units for each
Procurement product.
Set-up 40,000 No. of production All the three products are produced in
Runs production runs of 48 units.
Quality 28,240 No. of Inspections Done for each production run.
Control
Maintenance 1,28,000 Maintenance Total maintenance hours were 6,400
hours and was allocated in the ratio of 1:1:2
between X, Y & Z.
Required:
1. Calculate the total cost per unit of each product using the Absorption Costing Method
2. Calculate the total cost per unit of each product using the Activity Based Costing Method.
[(i) `148.50, `149.00, ` 273.50;(ii) `160.29, `151.92, `264.18]

Q.17. PQR Ltd. is engaged in the production of three products P, Q and R. The company calculates
activity cost rates on the basis of cost Driver capacity which is provided as below:
Activity Cost Driver Cost Driver Capacity Costs
Direct Labour hours Labour hours 30,000 Labour hours 300000
Production runs No. of Production runs 600 Production runs 180000
Quality Inspections No. of Inspection 8000 Inspections 240000
The consumption of activities during the period is as under:
X Y Z
Direct Labour hours 10,000 8,000 6,000
Production runs 200 180 160
Quality Inspection 3000 2500 1500
You are required to:
(i) Compute the costs allocated to each Product from each Activity.
(ii) Calculate the cost of unused capacity for each Activity.
(iii) A potential customer has approached the company for supply of 12,000 units of a new product
'S' to be delivered in lots of 1500 units per quarter. This will involve an initial design cost of
30,000 and per quarter production will involve the following:
Direct Material 18 ,000
Direct Labour hours 1,500 hours
No. of Production runs 15
No. of Quality Inspection 250
Prepare cost sheet segregating Direct and Indirect costs and compute the Sales value per quarter of
product 'S' using ABC system considering a markup of 20% on cost.
[(i) P: `1,00,000, `60,000, ` 90,000; Q:`80,000, `54,000, `75,000; R:`60,000, `48,000, ` 45,000
(ii) `60,000, `18,000, `30,000]

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Q.18. ABC Bank is examining the profitability of its Premier Account, a combined Savings & Cheque
account. Depositors receive a 7% annual interest on their average deposit. ABC Bank earns an
interest rate spread of 3% (the difference between the rate at which it lends money and rate it pays
to depositors) by lending money for home loan purpose at 10%.
The Premier Account allows depositors unlimited use of services such as deposits, withdrawals,
cheque facility, and foreign currency drafts. Depositors with Premier Account balances of
` 50,000 or more receive unlimited free use of services. Depositors with minimum balance of less
than ` 50,000 pay ` 1,000 a month service fee for their Premier Account ABC Bank recently
conducted an activity-based costing study of its services. The use of these services in 2020-21 by
three customers is as follows:
Account Usage
Activity Customer X Customer Y Customer Y
based Cost
per
"Transaction"
Deposits/withdrawal with teller ` 125 40 50 5
Deposits/withdrawal with ` 40 10 20 16
automatic teller machine (ATM)
Deposits withdrawal on pre- 25 0 12 60
arranged monthly basis
Bank Cheques written 400 9 3 2
Foreign Currency drafts ` 600 4 1 6
Inquires about Account ` 75 10 18 9
balance
Average Premier ` 55,000 ` 40,000
Account balance for 2020-21 ` 12,50,000
Assume Customer X and Z always maintain a balance above ` 50,000, whereas Customer Y
always has a balance below ` 50,000.
Required:
(i) Compute the 2020-21 profitability of the customers X, Y and Z Premier Account at ABC
Bank.
(ii) Premier Accounts? Why might ABC bank worry about this Cross subsidization, if the Premier
Account product offering is profitable as a whole?
(iii) What changes would you recommend for ABC Bank's Premier Account

Solution:
(i) Customer Profitability Analysis of ABC Bank Premier Account
Activity Activity
Based Cost Customer
(`)
X(`) Y (`) Z(`)
Deposit/Withdrawal with teller 125 5,000 6,250 625
(125 × 40) (125 × 50) (125 × 5)
Deposits/Withdrawal with ATM 40 400 800 640
(40 × 10) (40 × 20) (40 × 16)

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 Deposits Withdrawal as per arranged 25 Nil 300 1,500
monthly basis (25 × 12) (25 × 60)
Bank Cheques Written 400 3,600 1,200 800
(400 × 9) (400 × 3) (400 × 2)
Foreign Currency drafts 600 2,400 600 3,600
(600 × 4) (600× 1) (600 × 6)
Inquiries about Account balance 75 750 1,350 675
(75 × 10) (75 × 18) (75 × 9)
Customer Cost 12,150 10,500 7,840
Spread on Average Balance Maintained 3% 1,650 1.200 37,500
(3% × (3% × (3% ×
55,000) 40,000) 12,50,000)
Minimum Balance fee ` 1,000 p.m. 12,000
Customer Benefit 1,650 13,200 37,500
Customer Profitability (10,500) 2,700 29,660

(ii) Above computation shows that Customer Z is most profitable and' is cross-subsidising the
most demanding customer X. Customer Y is paying for the services used, because of not being
able to maintain minimum balance. No doubt, 'Premier Account' product offering is profitable
as a whole, but the worry is of not finding customers like customer Z who will maintain a
balance higher than the stipulated minimum. It appears, the minimum balance stipulated is
inadequate considering the services availed by depositors in 'Premium Account'.
(iii) The changes suggested to ABC Bank's 'Premier Account' are as follows:
 Increase the requirement of minimum balance from ` 50,000 to ` 1,00,000.
 Charge for value added services like Foreign Currency Drafts.
 Do not allow deposits/withdrawal below ` 10,000 at the teller. Only ATM machine
withdrawal is allowed.
 Inquiries about account balance to be entertained only through Phone Banking/ATM.
Q.19. X Ltd. makes a single product with the following details:
Current Situation Proposed Change
Selling Price (`/unit) 10
Direct Costs (`/unit) 5
Present number of setups per period, (before each 42
production run, set up is done)
Cost per set up (`) 450 Decrease by ` 90
Production units per run 960 1,008
Engineering hours for production period 500 4522
Cost per engineering hour (`) 10
Solution:
Statement Showing 'Non-unit Level' Overhead Costs
Current Situation Proposed Change
No. of Production Runs/ Setups 42 40
960 runs × 42 setups
1008 units
Cost per Setup ` 450 ` 360
Production Units per run 960 units 1,008 units
Production Units 40,320 40,320
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 (960 units × 42)
Engineering Hrs. 500 427
Engineering Cost per hour ` 10 ` 10
(i) Break Even Point (Changed Scenario)
Break Even Point
= Fixed Cost + (Setup Cost × No. of Setups) + (Engineering Costs × No. of Engineering Hrs)
(Price – Unit Variable Cost)
= ` 72,100 + (` 360 × 40 Setups) + (` 10 × 422 hrs,)
18,144 units
(` 10 – ` 5)

Break Even Point (No. of Production Runs)

= Break Even (units) 18,144 units
=
Production (units per run) 1,008 units
(ii) A company should adopt Activity Based Costing (ABC) system for accurate product costing,
as traditional volume based costing system does not take into account the Non-unit Level
Overhead Costs such as Setup Cost, Inspection Cost, and Material Handling Cost etc. Cost
Analysis under ABC system showed that while these costs are largely fixed with respect to
sales volume, but they are not fixed to other appropriate cost drivers. If breakup of the
remaining ` 72,100 fixed costs consist of only a small portion of these costs, ABC need not be
applied.
However, it may also be noted that the primary study has resulted in cost savings. If the
savings in cost are expected to exceed the cost of study and implementing ABC, it may be
justified. Further it is pertinent to mention that ABC offers no increase in product-costing
accuracy for Space to write important points for revision single-product setting.

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