Applied Commercial and Quality Principles in
Engineering
Assignment 2: Activity-Based Costing
Learning Aim B: Explore activity-based costing as a method to control costs and to determine if an
engineering product or service is profitable.
A research and problem solving project to explore the costs associated with engineering activities and
to complete an activity-based cost model for a product or service.
,Content
Task 1: Why an Engineering Company Controls Costs 2
Introduction 2
Cost analysis of a hydraulic valve 2
Break even chart 3
Cost Control 3
There are two key steps involved in a successful project analysis: 4
Step One: Calculating All-Inclusive Cost 4
Step Two: Calculate Benefits 4
Hidden Costs 5
In Summary 5
Task 2: Costs Associated with Producing a Hydraulic Valve 5
Production cost 6
Direct Costs 6
Variable costs 7
Semi-variable costs 7
Fixed Costs 7
Examples of fixed cost 8
General/Administration costs 8
Task 3: Iterative Activity based cost model 10
Step 1: Identify costs associated with producing the valve and how much it sells for 11
Step 3: We can now calculate the total direct costs of manufacturing the product 12
Step 4: Considering the relevant activity cost pools and identify activity drivers within those
activity pools for direct costs. 12
Step 5: Considering the relevant activity cost pools and identify activity drivers within those
activity pools for indirect costs. 13
Step 6: Once the direct costs, indirect costs and sales revenue are collected we can calculate the
organisation profitability on this product 14
Step 7: From this analysis manufacturing the hydraulic valve is profitable 14
Task 4: Refined activity-based costing model 14
How costs are categorised 15
Grouping costs using a cost hierarchy 15
Cost areas that have the greatest impact on the profitability of the product 15
Evaluate the reasons for producing an activity-based cost model 16
Advantages of ABC 16
More Precise Information 16
A Better View of Process Flow 16
Reducing Costs 17
1
, Task 1: Why an Engineering Company Controls Costs
Introduction
The purpose of this task is to analyse the costs and profitability of manufacturing a new hydraulic
system in the next generation of aircraft.
Cost analysis of a hydraulic valve
Machining centre purchasing price £1,000,000.00
Depreciation (Straight line p/a) 15%
Control Valve
Cost of materials and parts Quantity Cost per Total cost for
item (£) material (£)
Aluminium casting 1 £90.00 £90.00
Connector 4 £10.00 £40.00
Spring 2 £13.00 £26.00
Piston 1 £40.00 £40.00
Solenoid actuator (includes seals and 1 £160.00 £160.00
fixings)
Limit switch 2 £32.00 £64.00
Machining time per unit 2 hours
Machining centre cost per hour £100.00
Assembly time per unit 2 hours
Labour cost per hour £40.00
Test and certification time per unit 0.60 hours
Labour cost per hour £45.00
Variable overheads (% labour cost) 34.00%
2
Engineering
Assignment 2: Activity-Based Costing
Learning Aim B: Explore activity-based costing as a method to control costs and to determine if an
engineering product or service is profitable.
A research and problem solving project to explore the costs associated with engineering activities and
to complete an activity-based cost model for a product or service.
,Content
Task 1: Why an Engineering Company Controls Costs 2
Introduction 2
Cost analysis of a hydraulic valve 2
Break even chart 3
Cost Control 3
There are two key steps involved in a successful project analysis: 4
Step One: Calculating All-Inclusive Cost 4
Step Two: Calculate Benefits 4
Hidden Costs 5
In Summary 5
Task 2: Costs Associated with Producing a Hydraulic Valve 5
Production cost 6
Direct Costs 6
Variable costs 7
Semi-variable costs 7
Fixed Costs 7
Examples of fixed cost 8
General/Administration costs 8
Task 3: Iterative Activity based cost model 10
Step 1: Identify costs associated with producing the valve and how much it sells for 11
Step 3: We can now calculate the total direct costs of manufacturing the product 12
Step 4: Considering the relevant activity cost pools and identify activity drivers within those
activity pools for direct costs. 12
Step 5: Considering the relevant activity cost pools and identify activity drivers within those
activity pools for indirect costs. 13
Step 6: Once the direct costs, indirect costs and sales revenue are collected we can calculate the
organisation profitability on this product 14
Step 7: From this analysis manufacturing the hydraulic valve is profitable 14
Task 4: Refined activity-based costing model 14
How costs are categorised 15
Grouping costs using a cost hierarchy 15
Cost areas that have the greatest impact on the profitability of the product 15
Evaluate the reasons for producing an activity-based cost model 16
Advantages of ABC 16
More Precise Information 16
A Better View of Process Flow 16
Reducing Costs 17
1
, Task 1: Why an Engineering Company Controls Costs
Introduction
The purpose of this task is to analyse the costs and profitability of manufacturing a new hydraulic
system in the next generation of aircraft.
Cost analysis of a hydraulic valve
Machining centre purchasing price £1,000,000.00
Depreciation (Straight line p/a) 15%
Control Valve
Cost of materials and parts Quantity Cost per Total cost for
item (£) material (£)
Aluminium casting 1 £90.00 £90.00
Connector 4 £10.00 £40.00
Spring 2 £13.00 £26.00
Piston 1 £40.00 £40.00
Solenoid actuator (includes seals and 1 £160.00 £160.00
fixings)
Limit switch 2 £32.00 £64.00
Machining time per unit 2 hours
Machining centre cost per hour £100.00
Assembly time per unit 2 hours
Labour cost per hour £40.00
Test and certification time per unit 0.60 hours
Labour cost per hour £45.00
Variable overheads (% labour cost) 34.00%
2
