Inventory Control, Labour Cost, Overhead Allocation & Activity-Based Costing (ABC)

1. Material Inventory Control: Stock Levels & ABC Analysis

Raw materials typically constitute $50\%$ to $70\%$ of the total manufacturing cost of finished goods. Effective inventory management establishes quantitative thresholds to prevent both stockouts and excessive carrying costs:

• Reorder Level (ROL): The inventory threshold that signals the procurement division to release a fresh purchase requisition: $$\text{ROL} = \text{Maximum Usage per Day} \times \text{Maximum Lead Time (Days)}$$
• Minimum Stock Level (Safety Buffer): The lowest stock cushion to prevent plant shutdown under delayed deliveries: $$\text{Minimum Level} = \text{ROL} - (\text{Normal Average Usage} \times \text{Normal Average Lead Time})$$
• Maximum Stock Level: The upper quantity ceiling above which inventory must not accumulate to avoid capital lock-up and deterioration: $$\text{Maximum Level} = \text{ROL} + \text{EOQ} - (\text{Minimum Usage} \times \text{Minimum Lead Time})$$
• Danger Stock Level: Emergency stock boundary where production is threatened; purchases are arranged on priority expediting: $$\text{Danger Level} = \text{Average Daily Consumption} \times \text{Maximum Emergency Lead Time}$$
• ABC Inventory Classification (Pareto Principle):
  • Category A: High value ($70\%$ of inventory investment), low volume ($10\%$ of total items). Requires tight daily management and strict physical audits.
  • Category B: Moderate value ($20\%$ of investment), moderate volume ($20\%$ of items). Managed with standard reorder points.
  • Category C: Low value ($10\%$ of investment), high volume ($70\%$ of items). Managed with periodic batch reviews and simple two-bin visual controls.

2. Labour Cost Control, Idle Time & Incentive Wage Systems

Human capital accounting involves auditing worker productivity, eliminating unbudgeted idle time, and aligning remuneration with operational output:

• Normal Idle Time: Unavoidable operational pauses inherent in the production setup (e.g., walking to tool crib, machine setup calibration, tea breaks). Treated as part of factory production cost and absorbed into overhead recovery rates.
• Abnormal Idle Time: Avoidable non-productive intervals resulting from managerial inefficiency (e.g., power grid failure, machine breakdown, raw material stockouts, industrial strikes). Charged directly to Costing Profit and Loss Account to prevent unit cost inflation.
• Halsey Premium Plan: Formulated by F.A. Halsey. A standard time ($S$) is set for each task. If the worker completes it in actual time ($T$) where $T < S$, they receive guaranteed time wages plus a bonus of $50\%$ of time saved: $$\text{Total Earnings} = (T \times R) + 50\% (S - T) \times R$$
• Rowan Premium Plan: Formulated by James Rowan. The bonus is a proportion of time wages, determined by the ratio of time saved to standard time: $$\text{Total Earnings} = (T \times R) + \left(\frac{S - T}{S}\right) \times (T \times R)$$ Key Distinction: Under Rowan's plan, a worker can never double their hourly rate, which prevents runaway earnings if standard times are set too loose.

3. Overhead Accounting, Allocation, Apportionment & Machine Hour Rate

Overheads encompass all indirect material, indirect labor, and indirect expenses that cannot be directly attributed to a single cost unit:

• Overhead Allocation: Allotment of whole items of cost directly to specific cost centers (e.g., charging specific canteen wages directly to the canteen department).
• Overhead Apportionment (Primary Distribution): Allotment of common indirect expenditures across multiple departments using rational basis:
  • Factory Rent, Rates & Taxes → Floor Area (sq. meters) occupied by each department.
  • Plant Depreciation, Machine Insurance → Capital Book Value of Machinery.
  • Power & Electricity → Horsepower (HP) rating of machines multiplied by operating hours.
  • Canteen & Welfare Expenses → Headcount (Number of workers) in each department.
• Secondary Distribution (Re-Apportionment): Redistributing service department costs (e.g., Maintenance, Stores) to production departments using direct method, step-down method, repeated distribution, or simultaneous linear equations.
• Machine Hour Rate (MHR): In mechanized factories, overheads are absorbed based on operating machine hours: $$\text{Machine Hour Rate (MHR)} = \frac{\text{Standing Fixed Charges} + \text{Running Machine Variable Costs}}{\text{Effective Annual Machine Hours}}$$

4. Activity-Based Costing (ABC): Architecture, Cost Pools & Drivers

Developed by Professors Robert Kaplan and Robin Cooper of Harvard Business School, Activity-Based Costing (ABC) revolutionized cost accounting by addressing the distortions of traditional volume-based overhead absorption:

• The Flaw of Traditional Costing: Traditional systems allocate overheads using volume-driven bases (direct labor hours, machine hours). Consequently, high-volume simple products over-subsidize low-volume complex custom products that consume disproportionate setups and quality audits.
• Foundational ABC Axiom: "Activities consume resources; products and services consume activities."
• Cost Pool: An aggregate of all indirect costs associated with a distinct operational business activity (e.g., Machine Setup Cost Pool, Quality Inspection Cost Pool, Material Procurement Cost Pool).
• Cost Driver: Any factor or event that causes a change in the total cost of an activity:
  • Transaction Drivers: Count how often an activity is performed (e.g., number of purchase orders, number of machine setups).
  • Duration Drivers: Measure the time required to perform an activity (e.g., setup hours, inspection hours).
  • Intensity Drivers: Directly charge resources for complex, high-effort activities.
• Activity Cost Driver Rate: $$\text{Cost Driver Rate} = \frac{\text{Total Activity Cost Pool (\text{₹})}}{\text{Total Volume of Cost Driver}}$$

6. Corporate Case Vignette: ITC Limited Supply Chain & ABC

7. AKTU University Examination Question Bank