THEORY QUESTIONS
Q1. Explain Activity Based Budgeting. [Nov. 2018, 5 Marks]
Ans.:
Activity Based Budgeting analyse the resource input or cost for each activity.
It provides a framework for estimating the amount of resources required as per the budgeted level of activity.
Actual results can be compared with budgeted results to highlight (both in financial and non-financial terms) those activities with major discrepancies from budget for potential reduction in supply of resources.
It is a planning and control system which seeks to support the objectives of continuous improvement.
It means planning and controlling the expected activities of the organisation to derive a cost effective budget that meet forecast workload and agreed strategic goals.
ABB is the reversing of the ABC process to produce financial plans and budgets.
Q2. What is the fundamental difference between Activity Based Costing System (ABC) and Traditional Costing System? Why more and more organisations in both the manufacturing and non-manufacturing industries are adopting ABC? [ICAI Module]
Ans.: Fundamental difference between ABC and Traditional costing are as follows:
Activity Based Costing
OH are related to activities grouped into cost pools.
Costs are related to activities and hence are more realistic.
Traditional Absorption Costing
OH are related to cost centers/departments.
Costs are related to cost centers and hence not realistic of cost behaviour.
Activity-wise Cost Drivers are determined.
Time (Hours) is assumed to be the only cost driver governing cost in all departments. CHAPTER
ACTIVITY BASED COSTING
Activity Based CostingTraditional Absorption Costing
Specific activity-wise recovery rates are used. There is no concept of single overhead recovery rate.
Costs are assigned to Cost Objects, e.g. customers, services, distribution channels, products, departments, etc.
Essential activities can be simplified and unnecessary activities can be eliminated. Thus, corresponding costs are also reduced/minimized. Hence ABC aids cost control.
Q3. Explain the following terms:
(i) Cost Object
(ii) Cost Driver
Either multiple overhead recovery rates (for each department) or single overhead recovery rate may be used.
Costs are assigned to Cost Units, i.e. to products or jobs or hours.
Cost Centers/departments cannot be eliminated. Hence, not suitable for cost control.
(iii) Cost Pool. [ICAI Module]
Ans.:
(i) Cost Object: It is an item for which cost measurement is required e.g. product or customer.
(ii) Cost Driver: It is a factor that causes a change in the cost of an activity.
Categories of cost driver:
Resource Cost Driver: It is a measure of quantity of resources consumed by an activity. It is used to assign the cost of a resource to an activity or cost pool.
Activity Cost Driver: It is a measure of the frequency and intensity of demand, placed on activities by cost objects. It is used to assign activity costs to cost objects.
(iii) Cost Pool: It represents a group of various individual cost items. It consists of costs that have same cause and effect relationship e.g. machine set-up.
Q4. Describe the various levels of activities under ‘ABC’ methodology. [Nov. 2020, 4 Marks]
Ans.:
1. Unit level activities: Those activities for which the consumption of resources can be identified with the number of units produced e.g. use of indirect materials/consumables tends to increase in proportion to the number of units produced.
2. Batch level activities: The activities such as setting up of a machine or processing a purchase order are performed in batches. The cost of batch related activities varies with number of batches made, but is common (or
fixed) for all units within the batch e.g. (i) Material ordering, where an order is placed for every batch of production; or (ii) Machine set-up costs, where machines need resetting between each different batch of production.
3. Product level activities: Activities which are performed to support different products in product line e.g. designing the product, producing parts specifications, keeping technical drawings of products up to date.
4. Facilities level activities: Those activities which cannot be directly attributed to individual products. These activities are necessary to sustain the manufacturing process and are common and joint to all products manufactured e.g. maintenance of buildings, plant security.
Q5. What are the advantages of ABC? [ICAI Module]
Ans.:
More accurate costing of products/services. Overhead allocation is done on logical basis.
Enables better pricing policies by supplying accurate cost information. Utilizes unit cost rather than just total cost.
Help to identify non-value added activities which facilitates cost reduction.
It is helpful to the organizations with multiple products. It highlights problem areas which require attention of the management.
Q6. State the limitations of ABC? [ICAI Module]
Ans.:
It is more expensive, particularly in comparison with traditional costing system.
It is not helpful to the small organizations. It may not be applied to organizations with limited products. Selection of the most suitable cost driver may not be easy.
Q7. Which are the stages required in the implementation of ABC? [ICAI Module]
Ans.:
(1) Staff Training: Workforce co-operation is essential for successful implementation of ABC. Staff training should be done to create an awareness on the purpose of ABC.
(2) Process Specification: Informal, but structured interviews with key members of personnel will identify the different stages of the production process, the commitment of resources to each, processing times and bottlenecks.
(3) Activity Definition: The activities must be defined clearly in the early stage in order to manage the problems, if any, effectively.
(4) Activity Driver Selection: Cost driver for each activity shall be selected.
(5) Assigning Cost: A single representative activity driver can be used to assign costs from the activity pools to the cost objects.
Q8. What are the key elements of Activity Based Budgeting? [ICAI Module]
Ans.:
The three key elements of activity based budgeting are as follows:
Type of work to be done
Quantity of work to be done
Cost of work to be done.
Q9. What are the benefits of Activity Based Budgeting? [ICAI Module] OR
Discuss the usefulness/suitability of Activity Based Costing. [Jan. 2026, 4 Marks]
Ans.:
It can enhance accuracy of financial forecasts and increasing management understanding.
When automated, ABB can rapidly and accurately produce financial plans and models based on varying levels of volume assumptions. It eliminates much of the needless rework created by traditional budgeting techniques.
Q10. What is mean by cost driver? Give its different categories. Suggest suitable cost drivers (at least two) in the following business functions:
(i) Distribution
(ii) Research and Development
(iii) Customer services [Nov. 2023, 4 Marks]
Ans.:
Cost Driver: It is a factor that causes a change in the cost of an activity. There are two categories of cost driver.
Resource Cost Driver: It is a measure of the quantity of resources consumed by an activity. It is used to assign the cost of a resource to an activity or cost pool.
Activity Cost Driver: It is a measure of the frequency and intensity of demand, placed on activities by cost objects. It is used to assign activity costs to cost object.
Distribution
Number of units distributed
Number of customers
Research and Development
Number of research projects
Personnel hours on a project
Customer Service
Number of service calls
Number of products serviced
Hours spent on servicing products
Q11. Cosmos Limited uses activity based costing and accumulates overhead costs in the following cost pools:
(1) Human Resources
(2) Maintenance of buildings
(3) Parts Management
(4) Plant security
(5) Purchasing
(6) Floor manager’s salary
(7) Quality control
(8) Machine set-up
(9) Designing the product
(10) Receiving Department
Classify each cost pool as per cost hierarchy i.e. unit level, batch level, product level or facility level. [May 2025, 5 Marks]
Ans.:
S. No.Cost PoolCost Hierarchy Level
(1)Human ResourcesFacility-level
(2)Maintenance of buildingsFacility-level
(3)Parts ManagementBatch-level/Product Level
(4)Plant securityFacility-level
(5)PurchasingBatch-level
(6)Floor manager’s salaryFacility-level
(7)Quality controlBatch-level/Unit Level
(8)Machine set-upBatch-level
(9)Designing the productProduct-level
(10)Receiving DepartmentBatch-level
PRACTICAL QUESTIONS PRACTICAL
Q1. 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:
Production quantity (Units)4,0003,0001,600
Resources per Unit:
– Direct Materials (Kg.)463
– Direct Labour (Minutes)304560
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:
2. The cost drivers identified were as follows:
Material handlingWeight of material handled
Storage costsNumber of batches of material
ElectricityNumber of Machine operations
3. Data on Cost Drivers was as follows:
For complete production:
Batches of material10515
Per unit of production: Number of Machine operations632
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? [ICAI Module]
Ans.:
1. Traditional Absorption Costing
Total budgeted direct labour hours:
4,000 × 30 min + 3,000 × 45 min + 1,600 × 60 min 60 min
Total joint cost Total sale value = 5,800 hours
Overhead rate per direct labour hour: = Budgeted overheads ÷ Budgeted labour hours
= ` 99,450 ÷ 5,850 hours
= ` 17 per direct labour hour
Unit Costs:
Direct Costs: - Direct Labour5.007.5010.00 - Direct Material8.0012.006.00 Production Overhead:8.50
Total unit costs21.5032.2533.00 Number of units4,0003,0001,600
Total costs86,00096,75052,800
2. Activity Based Costing
Quantity (units)4,0003,0001,600-
Material Weight per unit (Kg.)463-
Total material weight16,00018,0004,80038,800
Machine operations per unit632Total operations24,0009,0003,20036,200
Total batches of Material1051530
Material handling rate per kg. = ` 29,100 ÷ 38,800 kg. = ` 0.75 per kg.
Electricity rate per machine operations = ` 39,150 ÷ 36,200 = ` 1.081 per machine operations
Storage rate per batch = ` 31,200 ÷ 30 batches = ` 1,040 per batch
Direct material8.0012.006.00
Overheads:
3. The difference in the total costs under the two systems is due to the differences in the overheads borne by each of the products. The Activity Based Costs appear to be more precise.
Q2. A consultancy firm provides project management service in three sectors - Technology, Healthcare and Education. The Project management service covers development and implementation of software for various MIS requirements of its clients. The fees charged per project is as follows:
` 1,20,000
` 1,10,000
The company uses Activity-Based Costing (ABC) to allocate its overhead costs. For the month of August 2025, the following informations are provided:
Overhead Costs and Activities:
ActivityTotal Cost (`)Cost Driver
Management of Projects 8,10,000Number of projects
Consulting Service Delivery
Client Interaction & Meetings
You are required to:
hours
of client meetings
development hours
(i) Prepare a statement showing the total cost and per project cost of project management service for each service sector - Technology, Healthcare and Education using Activity Based Costing Approach.
(ii) Identify the most profitable sector based on profitability percentage on fees charged. [Sept. 2025, 8 Marks]
Ans.:
(i) Statement showing calculation of Cost Driver rate
Consulting Service Delivery @ ` 30 per hour (6,400, 5,600, 2,000) 1,92,0001,68,00060,000
Client Interaction and Meeting @ ` 7,000 per meeting (30,20,40) 2,10,0001,40,0002,80,000 Administration and Support @ ` 70 per hour (10,000, 7,000, 5,000) 7,00,0004,90,0003,50,000
Total Cost15,07,00010,00,5008,92,500
