Question

Azion Manufacturing is a company that produces two types of cleaning detergents, Sunny Clear and Rosy Nice. Previously, Azion Manufacturing used single rate/ traditional costing system in computing its product overhead costs. Mr. Yeong, the newly appointed Chief Finance Manager decides to implement the Activity- Based Costing (ABC) system starting this year in computing the product costs. Below is the information gathered relates to the cost production of 40,000 units of Sunny Clear Detergent and 50,000 units of Rosy Nice Detergent:

	Sunny Clear	Rosy Nice
Direct material cost	RM15 per unit	RM10 per unit
Direct labour hour	1 hour per unit	1 hour per unit
Wages rate	RM10 per hour	RM10 per hour

Mr. Yeong suggests the following cost pools to compute the overhead costs using the Activity-Based Costing (ABC) system as stated below:

Activity Cost Pools	Cost Drivers	Estimated Overhead (RM)	Expected Usage
			Sunny Clear	Rosy Nice
Machine setups	No. of setups	300,000	1,000	2,000
Mixtures	No. of mixtures	180,000	600	900
Inspections	No. of inspections	240,000	10,000	15,000

Instructions

(a)        If the estimated total overhead costs are computed based on total direct labour hours, compute the overhead costs for both products using the single rate / traditional costing system.                                                                                                          (4 marks)

(b)       Based on answers in (a), compute the unit cost for each product using the single rate / traditional costing system.                                                                               (2 marks)

(c)        Compute the activity rate for each activity cost pool.                                         (4.5 marks)                                                                                                                        

(d)       Determine the unit cost for each product according to the ABC system.                                                                                                                                                                          (8 marks)

(e)        Comparing the answers in (b) and (d), which system is more appropriate to determine the overhead cost for both products. Explain.                                                             

Answer 1

A) Overhead cost using traditional costing system: (Figures in RM)

Total Overheads:

Machune Setup = 300,000

Mixtures = 180,000

Inspections = 240,000

720,000

Overhead Cost Allocation Table

Particulars	Sunny Clear	Rosy Nice
Units Produced (1)	40,000	50,000
Labour Hours per unit (2)	1 hour	1 hour
Total direct labour hours {(1)*(2)}	40,000 hours	50,000 hours

Overhead cost allocation( RM )

320,000 (720,000*40,000 / 90,000)

400,000 (720,000*50,000 / 90,000)

B) Calculation of unit cost of each product: (figures in RM)

Particulars	Sunny Clear	Rosy Nice
Direct material cost per unit (1)	15	10
Direst labour cost per unit (2)	10	10
Overhead cost per unit (3)	8 (320,000 / 40,000)	8 (400,000 / 50,000)
Total unit cost{1+2+3}	33	28

C) Computation of activiity rate for each activity cost pool:

Activity Cost Pools(1)	Estimated Overhead (RM) (2)	Cost Drivers(3)	Cost Driver quantity(4)	Activity rate(RM) (5) (2) / (4)
Machine setups	300,000	No. of setups	3,000	100
Mixtures	180,000	No. of mixtures	1,500	120
Inspections	240,000	No. of inspections	25,000	9.6

D) Unit cost of each product under ABC System:

Particulars	Sunny Clear	Rosy Nice
Total Direct material cost (1)	600,000 (40,000*15)	500,000 (50,000*10)
Total Direst labour cost (2)	400,000 (40,000*10)	500,000 (50,000*10)
Total Overhead cost:
Machine setups	100,000 (100*1000)	200,000 (100*2000)
Mixtures	72,000 (120*600)	108,000 (120*900)
Inspections	96,000 (9.6*10,000)	144,000 (9.6*15,000)
Total Overhead Cost (3)	268,000	452,000
Total Cost{1+2+3} (4)	1,268,000	1,452,000
Total no. of units (5)	40,000	50,000
Total Unit Cost { 4 / 5 }	31.7	29.04

E) Comparison: (figures in RM)

Particulars	Sunny Clear	Rosy Nice
Unit Cost as per Traditional Costing System	33	28
Unit Cost as per ABC System	31.7	29.04

Activity Based Costing(ABC) System is more appropriate to determine the overhead cost of both the products. This is so because it uses more relevant data for the calculation of overhead costs. 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.