Question

Prepared by: Bigeso Makenge (PGDA - TIA. EBA-UDOM) Tel: 0747 46 67 61 et Co Dreduces three products, A, B and call made from the same matonal. Until now, it has used absorption costing to allocate overheads to its products. The company is now considering an activity based system in the hope that it will improve profitability. Information for the three products for the last year is as follows A B С Production and sales volumes (units) 15,000 12.000 18.000 Selling price per unit $7.50 $12 $13 Raw material usage (kg) per unit 2 3 4 Direct labour hours per unit 0-1 0.15 0-2 Machine hours per unit 0-5 0-7 0.9 Number of production runs per annum 16 12 B Number of purchase orders per annum 24 28 42 Number of deliveries to retailers per annum 48 30 62 The price for raw materials remained constant throughout the year at $1-20 per ke Simarly, the direct labour cost for the whole workforce was $14-80 per hour. The annual overhead costs were as follows: $ Machine set up costs 26,550 Machine running costs 66,400 Procurement costs 48.000 Delivery costs 54.320 Required a) Calculate the full cost per unit for products A, B and under traditional absorption costing using direct labour hours as the basis for apportionment (5 marks)

Use Activity Based Budgeting not Absorption Costing

Answer 1

Answer-

a)	Cost per unit under traditional absorption costing, direct labor hours as basis of aportionment
	Total annual overhead costs :-
		$
	Material set up costs	26,550
	Machine running costs	66,400
	Procurement costs	48,000
	Delivery costs	54,320
	Total annual overhead costs	195,270
	Overhead absorption rate :-
		A	B	C	Total
	Production and Sales Volume ( units )	15,000	12,000	18,000
	Direct Labor Hours per unit	0.1	0.15	0.2
	Total Labor Hours	1,500	1,800	3,600	6,900
	Overhead absorption rate = $ 195,270 / 6,900 = $ 28.30 per hour
	Cost per unit :-
		A	B	C
		$	$	$
	Raw Material ( $ 1.20 * 2/3/4 )	2.4	3.6	4.8
	Direct Labor ( $ 14.80 * 0.1/0.15/0.2 )	1.48	2.22	2.96
	Overheads ( $ 28.30 * 0.1/0.15/0.2 )	2.83	4.25	5.66
	Cost per unit	6.71	10.07	13.42
b)	Cost per unit using activity based costimg
	Cost Drivers:-
	Cost pools	$	Cost Drivers
	Machine set up costs	26,550	36 production runs ( 16+12+8 )
	Machine running costs	66,400	*32,100 machine hours ( 7,500 + 8,400 + 16,200 )
	Procurement costs	48,000	94 purchase orders ( 24 + 28 + 42 )
	Delivery costs	54,320	140 deliveries ( 48 + 30 + 62 )
		195,270
	Cost per Machine set up	$ 26,550 / 36 = $ 737.50
	Cost per Machine hour	$ 66,400 / 32,100 = $ 2.068536
	Cost per order	$ 48,000 / 94 = $ 510.6383
	Cost per delivery	$ 54,320 / 140 = $ 388
	Allocation of Overheads to each product
		A	B	C	Total
		$	$	$
	Machine set up costs	11,800	8,850	5,900	26,550
	Machine running costs	15,514	17,376	33,510	66,400
	Procurement costs	12,255	14,298	21,447	48,000
	Delivery costs	18,624	11,640	24,056	54,320
		58,193	52,164	84,913	195,270
	Units Produced	15,000	12,000	18,000
	Overhead Cost per unit	3.88	4.35	4.72
	Cost per unit :-
		A	B	C
		$	$	$
	Raw Material ( $ 1.20 * 2/3/4 )	2.4	3.6	4.8
	Direct Labor ( $ 14.80 * 0.1/0.15/0.2 )	1.48	2.22	2.96
	Overhaeds	3.88	4.35	4.72
	Total Cost	7.76	10.17	12.48
*	Calculation of Machine Hours
		A	B	C	Total
	Production and Sales Volume ( units )	15,000	12,000	18,000
	Direct Machine Hours per unit	0.5	0.7	0.9
	Total Machine Hours	7,500	8,400	16,200	32,100
c)	Following Observation is made :-
	Product A
	Under Activity Based Costing, cost per unit of Product A is $ 7.76 which is 16 % higher than the cost of product A under traditional costing,. It is given that the Selling price per unit of Product A is $ 7.50, so it is clear that when overheads that give rise to cost of product A are taken into account, Product A makes loss. So, to improve the profitability of Product A, company should either increase the selling price of Product A or should somehow reduce the cost. Areas of concern are Number of Deliveries is 48,company should make efficiency here. Also, Machine set up cost of Product A is high, it should be reduced.
	Product B
	There is only difference of $ 0.10 for Product B under Activity based costing and traditional costing. Selling Price per unit is $ 12, so whatever method of costing is used, B is profitable .
	Product C
	Under Traditional Costing Method Product C is making Loss of $ 0.42, while Under Activity based costing, Product C is making a little profit of $ 0.52. For Product C Activity based costing is profitable.