Question

Can someone solve all three points for me?

Question 2 The management of Vegetarian Meals Ltd, who make three main product lines of ready-made vegetarian meals in batches for the restaurant trade, are reviewing the cost accounting policy in relation to overheads. Currently the company absorbs overheads on the basis of direct labour hours. Some of the management board feel that the company should switch to activity-based costing (ABC), as the product lines make different demands on the company's overhead resources - in particular, the Mexican Bean Feast product line requires a lot of advance soaking of a wide variety of raw beans and pulses, peeling and preparation and so on. You have been asked to demonstrate the difference between the existing and the proposed method of dealing with overheads. The following information is available to assist you: Mexican Bean Feast €36.00 €9 Italian Vegetarian Middle Eastern Pizza surprise €18.00 €24.00 €18 €13.5 12 minutes 6 minutes 60 €58.00 €60.00 3,600 4,500 Material (€12 per kilo) Labour (€9 per hour) Machine hours per unit Units per batch Sales price Sales demand Overhead costs: Machine related Quality testing Machine set-up costs Material movements 60 6 minutes 40 €63.00 3,200 €74,600 €17,045 €54,825 €60,100 driven by machine hours driven by number of units driven by number of batches driven by number of kilos a) Calculate the profit or loss on each product using traditional overhead recovery (plantwide rate using direct labour hours as a base) and assuming normal absorption costing. (10 marks) b) Calculate the profit or loss on each product using ABC overhead recovery and normal absorption costing. (10 marks) c) Explain if Vegetarian Meals Ltd should replace its existing traditional costing system with activity-based costing? (5 marks) Page 3 of 6

Answer 1

Solution 2:

Part 1: Profit and Loss using Traditional Overhead Recovery Method:

1. Total Overhead Cost = € 206,570
2. Total Labour Hours Required:

Particulars	Mexican Bean Pizza	Italian Veg Pizza	Middle Eastern Surprise
Labour hour Per Unit	1 Hour (€9/9)	2 Hour (18/9)	1.5 Hour (13.5/9)
Sales Unit	3200	3600	4500
Total Labour Req	3200 hrs	7200 hrs	6750 hrs
Total Labour Hours	17150 Hours

3. Overhead Cost per Labour Hour = €206570/17150

= 12.04 / hour

4. Statement of Profit and Loss :-

Particulars	Mexican Bean Pizza	Italian Veg Pizza	Middle Eastern Surprise
Sales Price	63	58	60
Sales Demand	3200	3600	4500
Total Sale	201600	208800	270000
Less:
Material Cost	115200 €36*3200	64800 18*3600	108000 24*4500
Labour Cost	28800 9*3200	64800 18*3600	60750 13.5*4500
Overhead Cost	38543.67 (12.04*3200)	86723.27 (12.04*7200)	81303.06 (12.04*6750)
Profit / (Loss)	19056.33	(7523.27 )	19946.94

Part 2: Profit and Loss using Absorption Based Costing Method:

Driver Cost:-

Particulars	Driver	Cost	Driver Total	Per Unit
Machine Related	Machine Hours	74600	1490 machine hours	=50.07 (74600/1490)
Quality Testing	No of Units	17045	11300 units	= 1.51 (17045/11300)
Machine Setup Cost	No of Batches	54825	215 batches	=255 (54825/215)
Material Movement	Number of Kilos	60100	24000 kilos	= 2.50 (60100/24000)

Statement of Profit and Loss

Particulars	Mexican Bean Pizza	Italian Veg Pizza	Middle Eastern Surprise
Sales Price	63	58	60
Sales Demand	3200	3600	4500
Total Sale	201600	208800	270000
Less:
Material Cost	115200 €36*3200	64800 18*3600	108000 24*4500
Labour Cost	28800 9*3200	64800 18*3600	60750 13.5*4500
Machine Related Cost	16021.48 (320 hrs * 50.07)	36048.32 ( 720* 50.07)	22530.20 ( 450 *50.07)
Quality Testing	4826.88	5430.24	6787.80
Machine Setup Cost	20400.00	15300.00	19125.00
Material Movement	24040.00	13522.50	22537.50
Profit / (Loss)	(7688.36 )	8898.94	30269.50

Part (C)

Yes Vegetarian Meals Ltd Should replace existing method with traditional method because, ABC focuses attention on cost drivers, the activities that cause costs to increase. Traditional absorption costing tends to focus on volume-related drivers, such as labour hours, while activity-based costing also uses transaction-based drivers, such as number of orders received. In this way, long-term variable overheads, traditionally considered fixed costs, can be traced to products.

Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them. ABC enables effective challenge of operating costs to find better ways of allocating and eliminating overheads. It also enables improved product and customer profitability analysis. It supports performance management techniques such as continuous improvement and scorecards.

Here, Profit as per ABC is wholly different from Absorption costing they should adopt ABC.