Question

Bernadette Inc. makes several products and uses one cost driver (direct labour hours) to assign overhead to the products. Bernadette has started to wonder whether the use of activity based costing (ABC) would be more appropriate. To start, Bernadette would like to investigate what the costing would look like for one product (Product A) using ABC.  Details are below.

Current Unit Information of Product A (using direct labour hours as the overhead cost driver)

Selling Price                $23

Direct Materials          $10

Direct Labour                  6

Overhead                        3

                                    $19

# of units of Product A sold    150,000

For ABC purposes, Bernadette has broken down the overhead into 4 main activities with related costs:

	Driver (total)	Total Cost	Product A’s consumption
Order Processing	10,000 orders	$500,000	3,000 orders
Batch setup	1,500 setups	800,000	350 setups
Equipment maintenance	35,000 machine hrs	1,400,000	20,000 MH
Packing	15,000 packs	100,000	2,000 packs

Required –

1. What is the total unit cost of Product A using activity based costing?
2. Is Product A currently under-costed or over-costed?
3. Give an example of one useful decision that Bernadette Inc. might make in relation to Product A now that they know a truer cost of Product A.

Answer 1

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Bernadette Inc.
Workings
Calculation of ABC rates for overhead		A	B	C=A/B
Activity cost pool	Cost Driver	Total Cost	Driver (total)	ABC rates
Order Processing	Number of orders	500,000.00	10,000.00	50.00
Batch setup	Number of batches	800,000.00	1,500.00	533.33
Equipment maintenance	Machine Hours	1,400,000.00	35,000.00	40.00
Packing	Number of packs	100,000.00	15,000.00	6.67
Total Overhead Cost		2,800,000.00
Allocation of overhead as per ABC to product A		See B	D	E=B*D
Activity cost pool	Cost Driver	ABC rates	Product A’s consumption	Amount
Order Processing	Number of orders	50.00	3,000.00	150,000.00
Batch setup	Number of batches	533.33	350.00	186,666.67
Equipment maintenance	Machine Hours	40.00	20,000.00	800,000.00
Packing	Number of packs	6.67	2,000.00	13,333.33
Total Cost assigned				1,150,000.00	F
Units sold				150,000.00	G
Overhead per unit				7.67	H=F/G
Answer a	Amount $
Direct Materials	10.00
Direct Labor	6.00
Overhead	7.67
Cost per unit	23.67
Answer b
Product A is currently under-costed because cost under ABC is $ 23.67 but presently its cost is $ 19. So it is under by $ 4.67 i.e. $ 23.67 less $ 19 equals $ 4.67.
Answer c
Product A sell price is $ 23. Its cost under ABC is $ 23.67. So company is incurring loss of $ 0.67 per unit. So its action should be to increase the price of the product.