Question

Skhumbuzo is a private business man who began his trade by operating a spaza shop in the vicinity of the University of Eswatini in the area of Kwaluseni. His business has a special focus on three hot dog product lines. his business has grown so much in recent months such that it is now competing at same level in the Kwaluseni area with established supermarket chains such as Pick'n Pay and OK bazaars. Due to this growth overheads have become a significant proportion of the business costs.

He recently hired Mpendulo an MBA student at the University of Eswatini as the finance manager. Mpendulo decided to implement cost accounting policies in relation to overheads that he learnt from his MBA cost accounting classes. He first experimented with traditional cost accounting policy. he decided to absorb overheads on the basis of direct labour hours. however, from his classes he learnt htat a cost accounting called ABC is quite superior to the traditional cost accounting system. Unfortunatel he did not grasp the concepts very well.

You have been asked to help him implement the ABC system. the following information has been made available for you:

                                                                  Wors Dog                         Russian Dog                 Eswatini Dog

Material ($12 per kilo)                                    $36                                    $18                             $24

Labour ($9 per hour)                                      $9                                       $18                            $13.50

Machine hours per unit                                6 minutes                            12 minutes                 6 minutes

Units per batch                                             40                                        60                             60

Sales price                                                  $63                                       $58                           $60

Sales demand                                            3,200                                    3,600                         4,500

Overhead Costs:

Machine related                                                $74,500 driven by machine hours

Quality testing                                                  $17,145 driven by number of units

Machine set-up costs                                        $54,825 driven by number of batches

Material movements                                          $60,000 driven by number of kilos

Required:

(a) Determine the profit or loss on each hot dog using the traditional absorption costing system

(b) Calculate the profit and loss on each product using the ABC system?

(c) Give recommendations on which is a better sytsem of the two

Answer 1

Solution:

	Wors Dog	Russian Dog	Eswatini Dog	Total
Material per Unit (Kilo) = Material Cost / $12	3.00	1.50	2.00
Labour per Unit (Hours) = Labour Cost / $9	1.00	2.00	1.50
Machine Hours (Hours) = Machine Hours Minutes / 60	0.10	0.20	0.10
Number of Kilo of Material = Sales Demand x Kilo per unit	9,600	5,400	9,000	24,000
Number of Batches = Sales Demand / Units per batch	80	60	75	215
Total Labour Hours = Labour per Unit x Sales Demand	3200	7200	6750	17150
Total Machine Hours = Machine Hour per Unit x Sales Demand	320	720	450	1490
Total Units	3200.00	3600.00	4500.00	11300

Overheads	$
Machine Related	74,500.00
Quality Testing	17,145.00
Machine Set up costs	54,825.00
Material Movements	60,000.00
Total Overhead Cost	2,06,470.00

Solution a) Calculation of Profit or loss on each Hot dog using traditional absorption costing method:

	Wors Dog		Russian Dog		Eswatini Dog
	Total $	Per Unit $	Total $	Per Unit $	Total $	Per Unit $
Sales	2,01,600.00	63.00	2,08,800.00	58.00	2,70,000.00	60.00
Less: Costs
Material	1,15,200.00	36.00	64,800.00	18.00	1,08,000.00	24.00
Labour	28,800.00	9.00	64,800.00	18.00	60,750.00	13.50
Overheads = Labour Hours / Total Labour Hours x Total Overheads	38,525.01	12.04	86,681.28	24.08	81,263.70	18.06
Total Cost	1,82,525.01	57.04	2,16,281.28	60.08	2,50,013.70	55.56
Profit = Sales - Total Cost	19,074.99	5.96	(7,481.28)	(2.08)	19,986.30	4.44

As per traditional costing, Wors Dog is the most profitable and Russian Dog is least profitable.

Solution b) Calculate the profit and loss on each product using the ABC system?

Calculation of Cost Driver Rate

Activity Pool Cost	Cost $	Cost Driver	Number of Activities	Rate Per Activity = Cost / Number of Activities
Machine Related	74,500.00	Machine Hours	1,490 Hours	$50.00 per hour
Quality Testing	17,145.00	Number of Units	11,300 Units	$1.52 per unit
Machine Set up costs	54,825.00	Number of Batches	215 Batches	$255.00 per batch
Material Movements	60,000.00	Number of Kilo of Material	24,000 Kilos	$2.50 per kilo
	2,06,470.00

	Wors Dog			Russian Dog			Eswatini Dog
Costs	Number of Activities	Activity Rate $	Cost $	Number of Activities	Activity Rate $	Cost $	Number of Activities	Activity Rate $	Cost $
Machine Related	320	50.00	16,000.00	720	50.00	36,000.00	450	50.00	22500
Quality Testing	3,200	1.52	4,855.22	3,600	1.52	5,462.12	4,500	1.52	6827.655
Machine Set up costs	80	255.00	20,400.00	60	255.00	15,300.00	75	255.00	19125
Material Movements	9,600	2.50	24,000.00	5,400	2.50	13,500.00	9,000	2.50	22500
Total Overhead Cost $	65,255.22			70,262.12			70,952.65
Number of Units	3,200			3,600			4,500
Overhead Cost per Unit $	20.39			19.52			15.77

	Wors Dog		Russian Dog		Eswatini Dog
	Total $	Per Unit $	Total $	Per Unit $	Total $	Per Unit $
Sales	2,01,600.00	63.00	2,08,800.00	58.00	2,70,000.00	60.00
Less: Costs
Material	1,15,200.00	36.00	64,800.00	18.00	1,08,000.00	24.00
Labour	28,800.00	9.00	64,800.00	18.00	60,750.00	13.50
Overheads = Labour Hours / Total Labour Hours x Total Overheads	65,255.22	20.39	70,262.12	19.52	70,952.65	15.77
Total Cost	2,09,255.22	65.39	1,99,862.12	55.52	2,39,702.65	53.27
Profit = Sales - Total Cost	(7,655.22)	(2.39)	8,937.88	2.48	30,297.35	6.73

As per ABC System, Eswatini Dog is the most profitable and Wors Dog is the least profitable.

Solution c) As compared to Traditional system, Activity Based Costing system is better.

Both methods estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The differences are in the accuracy and complexity of the two methods.

Traditional costing is more simplistic and less accurate than ABC, and typically assigns overhead costs to products based on an arbitrary average rate.

ABC is more complex and more accurate than traditional costing. This method first assigns indirect costs to activities and then assigns the costs to products based on the products’ usage of the activities.