QUESTION
You are just from attending a conference on Activity Based Costing (ABC) and you now wish to put your knowledge to practice by applying the principles of ABC to the four products currently made and sold by your client. Details of the four products and relevant information are given below for one period.
Product A B C D
Output in units 120 100 80 120
Costs per unit K K K K
Direct materials 40 50 30 60
Direct labour 28 21 14 21
Machine hours (per unit) 4 3 2 3
The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows:
K
Machine department costs (rent, business rates, depreciation and supervision) 10,430
Set-up costs 5,250
Stores receiving 3,600
Inspection/quality control 2,100
Materials handling and dispatch 4,620
You have ascertained that the ‘cost drivers' to be used are as listed below for the overhead costs shown:
Cost Cost driver
Set-up costs Number of production runs
Stores receiving Requisitions raised
Inspection/quality control Number of production runs
Materials handling and dispatch Orders executed
The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 42, each order being for a batch of 10 of a product.
Required:
(a) Calculate the total cost for each product if all overhead costs are absorbed on a machine hour basis.
(b) Calculate the total cost for each product using activity based costing.
(c) Calculate and list the unit product costs from your figures in (a) and (b) above to show the differences and to comment briefly on any conclusions which may be drawn which could have pricing and profit implications.
(d) Explain briefly five (5) circumstances which call for the application of activity based costing as opposed to absorption costing.