Question

FC Company makes two products, titanium Hubs and Sprockets. Data regarding the two products as follows:

                                                                                    Direct Labour              Annual Production

                                                                                    Hours Per unit            

Hubs                                                                            0.80                              10,000 units

Sprockets                                                                    0.40                              40,000 units            

Additional information about the company follows:

1. Hubs require $32 in direct materials per unit, and Sprockets require $18
2. The direct labour wage rate is $15 per hour
3. Hubs are more complex to manufacture than Sprockets and they require special equipment.
4. The ABC system has following activity cost pools:

Activity

                                                                                                _______________________

                                                            Estmiated                    Hubs    Sprockets        Total

Overhead Cost           

Machine Setups (no. of setups)                $72,000                 100      300                400

Special Processing (machine hours)       $200,000                 5000       0                  5,000

General Factory                                      $816,000                 NA     NA                 NA

(organization sustaining

Required:

1. Compute the Activity Rate for each activity cost pool. Did you compute an activity rate for all of the activity cost pools? Why?
2. Determine the unit product cost of each product according to the ABC system.
3. Discuss how Activity Based Costing helps bring in efficiency in manufacturing and cost control.
4. Critically discuss as to why are top management support and cross-functional involvement crucial when attempting to implement an activity based costing in an organization.
5. Analyze the limitations of Activity Based Costing.

Answer 1

Answer is given below

Activity Cost pool Total Activities Cost Pool $72,000 $200,000 $272,000 Activity Activity Rate $180.00 per machine set up $40.00 per machine hour Machine set ups Special processing Total Overheads 400 5,000 Activity rate is computed only for unit-level, batch-level and product-level activities Activity rate is not calculated for Organisation sustaining costs - General factory overheads 2 Allocation of Overheads as per ABC method Hubs Expected use of cost drivers Activity rate Cost Assigned Sprockets Expected use Activity of cost rate drivers 300 $180.00 Cost Assigned $54,000 100 5,000 $180.00 $40.00 $40.00 Machine set ups Special processing Total Allocation Total production Overhead cost per unit $18,000 $200,000 $218,000 10,000 $21.80 $54,000 40,000 $1.35 Unit Product cost Direct Material Direct Labor Manufacturing overhead Cost per unit Hubs $32.00 $12.00 $21.80 $65.80 Sprockets $18.00 $6.00 $1.35 $25.35 Hubs 0.80 Direct labor per unit Labor hour rate Direct labor cost per unit Sprockets 0.40 $15 $6.00 $15 $12.00 Allocation of overhead as per traditional method does not correlate the cost with activities consumed ABC method should be used because it has advantages. Below are the listed advantages -It helps in accurate product costing and taking reliable decisions - It helps in analysing All the activities and elimination of non value adding activity and thereby improving process efficiency - It helps in decision making like Product level profitability, launch of new products, customer level cost analysis, etc - It helps in accurate Product pricing - It helps in better cost management through cost control and cost reduction Activity Based Costing requires study of the activities needed in production. All are activities are pooled into activity pool and cost is assigned to each activity cost pool and then activity cost driver rate is calculated Departments may initially resist the change since this method requires study of activities unlike traditional method which directly applies overhead based on labor hours or machine hours basis Also initially implementation of ABC will involve some cost due to the efforts involved in its feasibility study and implementation Hence management should support the initial implementation and cross function teams like HR, marketing, engineering,etc should help the Finance team in implementation of the same by helping to conduct activity analysis in respective department Limitations of ABC Costing - ABC costing method is time consuming since it needs identification of activities and calculating activity cost driver rates - It needs specialized knowledge to apply the ABC costing method throughout the organisation - ABC method is not useful if cost is more than benefits involved in implementing it - All the cost incurred in the organisation cannot be analysed as per ABC method