Question

This is BBM206/05 Business Accounting II subject

Question 3 

Loci Sdn Bhd manufactures three products, X, Y and Z. Demand for products X and Y is relatively elastic whilst demand for product Z is relatively inelastic. Each product uses the same materials and the same type of direct labour but in different quantities. For many years, the company has been using full absorption costing and absorbing overheads on the basis of direct labour hours. Selling prices are then determined using cost plus pricing. This is common within this industry, with most competitors applying a standard mark-up. Budgeted production and sales volumes for X, Y and Z for the next year are 40,000 units, 32,000 units and 44,000 units respectively. 

The budgeted direct costs of the three products are shown below: 

Product RM per unit RM per unit RM per unit 25 30 Direct materials Direct labour (RM15 per hour) 28 45 22.50 

In the next year, Loci Sdn Bhd also expects to incur indirect production costs of RM2,129,600, which are analysed as follows: 

RM 380,000 378,000 Cost drivers Number of batches Number of purchase orders Cost pools Machine set up costs Material ordering costs Machine running costs General facility costs 890,000 481,600 Number of machine hours Number of machine hours 2,129,600

The following additional data relate to each product: 

800 Product Batch size (units) No of purchase orders per batch Machine hours per unit 800 10 

Loci Sdn Bhd wants to boost sales revenue in order to increase profits but its capacity to do this is limited because of its use of cost plus pricing and the application of the standard mark-up. The finance director has suggested using activity based costing (ABC) instead of full absorption costing, since this will alter the cost of the products and may therefore enable a different price to be charged.

 Required:

 You are the accountant of Loci Sdn Bhd. In an annual meeting, you are required by the finance director to take the following actions. 

a. Explain what is full absorption costing to the board of directors. [3 marks] 

b. Explain what is activity based costing- [3 marks] 

c. Explain the steps involved in applying activity-based costing. [4 marks]

d.  Calculate the budgeted full production cost per unit of each product using Loci Sdn Bhd's current method of absorption costing. All workings should be to two decimal places. [3 marks] 

e. Calculate the budgeted full production cost per unit of each product using activity based costing. All workings should be to two decimal places. [12 marks] 

f. Discuss the impact on the selling prices and the sales volumes OF EACH PRODUCT which a change to activity based costing would be expected to bring about. [5 marks]

Answer 1

(a) Full absorption cost: Absorption costing is one of approach which is used for the purpose of valuation of inventory or calculation of cost of the product in the company where all the expenses incurred by the company are taken into consideration i.e., it includes all the direct and indirect expenses incurred by the company during the specific period.

• Costs are related to cost centers and hence not realistic of cost behaviour.
• Time are assumed to be the only cost driver governing costs in all departments.

(b) Activity Based Costing: Activity Based Costing is an accounting methodology that assign costs to activities rather than products or services. This enables resources & overhead costs to be more accurately assigned to products & services that consumes them.

• Costs are related to activities and hence more realistic.
• Activity wise cost drivers are determined.

(c) Steps involved in applying Activity Based Costing:

1. Identification of the activities that may take place in an organisation.
2. Assigning costs to cost pool for each activity both support and primary activities, that caused them.
3. Support activities are then spread across the primary activities on some suitable base, which reflects the use of support activity. The base is the cost driver that is the measure of how the support activities are used.
4. Determine the cost drivers for each activity that will be used to relate the overheads collected in the cost pools to the cost objects/products.
5. Assigning the cost of activities to products according to product demand for activities. Activity cost driver rate = Total cost activity / Activity Driver

(d) Please refer below image

calculation of budgeted full production cost / unit of each product using Current method of Abeoophon costing : Total indirect cost = 9,129,600 calculation of direct labour bours: X Particel as 32000 44000 Production (unite) 40000 1.5 Labou hr/unit 2 (30115) (45(95) (22.5/15) Total labour Houes 80000 96000 66000 Total Labour Hours & 2,42.000 Hrs In direct cost to the = 2129600 - RM 8.80l4Y 242000 Product cost : particulars Direct materials Direct Labou Indirect cost 45 22.50 17.60 (2x8.8) 78.60 Product cost /unit 26.40 (3x8.8) 99.40 13.20 (1.5x8.8) 57.70