2. ABC Ltd 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                         50000 hrs                        Kilowatt Rs 200000

Quality Inspection                  Numbers of inspection            10000 inspection          Rs 300000

The Company makes three products, A, B and C.For the year ended March 31, 2004, the following consumption of cost drivers was reported:

Product                                   Kilowatt-hours                        Quality Inspection

A                                                         20000                                      7000

B                                                         40000                                      5000

C                                                         30000                                      6000

Compute the costs allocated to each product from each activity

Calculate the cost of unused capacity for each activity.

Solution:

We’ll perform the following steps to solve this problem:

Step 1: Calculate the Activity Cost Rates

ABC Ltd allocates overheads based on cost driver capacity, not actual usage. So, we calculate the activity cost rate as:

Activity Cost Rate = Total Cost ÷ Capacity

Step 2: Compute Total Cost Allocated to Each Product

Use the formula:

Cost Allocated to Product = Cost Driver Used × Activity Cost Rate

(a) Power Cost Allocation

P.N: Capacity = 50,000 hrs but actual use is 90,000 hrs, which exceeds capacity. This implies there's a mismatch — possibly a data error. However, assuming data is correct as given, the capacity is just for costing purposes; the actual use may exceed capacity, affecting unused capacity calculations.

(b) Quality Inspection Cost Allocation

Again, total usage (18,000 inspections) exceeds available capacity of 10,000, which suggests data inconsistency. But for cost allocation based on capacity-based rates, we proceed regardless of actual usage.

Step 3: Summary of Cost Allocation

Step 4: Cost of Unused Capacity

Now we compute unused capacity cost using:

Unused Capacity = Capacity – Actual Usage

Cost of Unused Capacity = Unused Capacity × Activity Cost Rate

(a) Power Activity

• Capacity = 50,000 hrs
• Actual Use = 90,000 hrs
• Since actual exceeds capacity, no unused capacity
• Cost of unused capacity = Rs 0

(b) Quality Inspection

• Capacity = 10,000 inspections
• Actual Use = 18,000 inspections
• Actual exceeds capacity → no unused capacity
• Cost of unused capacity = Rs 0

If the company were to base unused capacity strictly on difference between capacity and usage (even if usage > capacity), then unused capacity is zero.

Conclusion:

ABC Ltd follows Activity-Based Costing (ABC) where it uses cost driver capacity to calculate cost rates. This helps assign overheads more accurately than traditional methods. Despite the actual usage exceeding capacity in both activities, the cost rates remain unchanged because they’re based on maximum available resources, not actual consumption.

Here’s how it works:

• Power rate is Rs 4 per kilowatt-hour (Rs 200,000 ÷ 50,000 hrs)
• Inspection rate is Rs 30 per inspection (Rs 300,000 ÷ 10,000 inspections)

Using these rates, ABC allocates costs based on how much each product used the drivers. For example, Product A used 20,000 kWh and 7,000 inspections, so it gets Rs 290,000 total cost.

However, because actual usage exceeded capacity, there is no unused capacity for either activity. If usage had been lower than capacity, the difference would be considered idle resources and calculated as cost of unused capacity.

Thus, the model not only allocates cost more accurately but also helps in identifying inefficiencies and overuse of resources — although in this case, resources were over-utilized, indicating potential capacity constraints.