Question

Mer (c) Explain why overhead cost cost to produce one unit of each product. Plain why overhead cost shifted from the high-volume product (product B) he low volume product (product A) under activity based costing. A company has been applying factory overhead on the basis of direct labour hours using an overhead recovery rate of $60.00 per direct labour hour. One of their employees, a trainee accountant, has suggested that the company should change to activity based costing as it gives a more realistic result. Her suggestion is that the rates that should have been used, based on activities, are: Materials handling 1% of direct material used Machining costs $2.00 per machine hr Power $0.50 per khr Set up costs $5.00 per set up The company has decided to trial her rates and compare the results with the traditional method by selecting one of the current jobs which appears to be showing a loss when compared with the quoted price. Detail of the jobs are: Direct material costs $5,000 Direct labour costs $ 500 Other details: Direct labour hours Machine hours Number of kilowatt hours Number of set ups Quoted price $7,000 Required: Calculate the cost of the job using both methods. Which method appears to give the more realistic result when compared with the quoted price?

Answer 1

Answer is given below

Job cost as per Traditional method Direct Material $5,000 Direct Labor $500 Overhead applied $3,000 (50 hours X $60) Total job cost $8,500 $5,000 $500 Job cost as per ABC method Direct Material Direct Labor Overhead applied Materials handling Machining cost Power Set ups Total Job Cost $50 (1% of $5,000) (100 * $2) (100 * $0.50) $305 (1 * $5) $5,805 Explanation: ABC method of job costing gives realistic picture of job cost ABC method uses activities consumed for job costing As per traditional method cost is allocated based on direct labor hours with out assigning cost to individual activities consumed for job Hence ABC method of job costing is more realistic and accurate compared to traditional method of cost allocation