- 20 Marks
MA – L2 – Q12a – Activity-based costing
Question
MCC has total budgeted production overheads for next year of GH₵816,000 and has traditionally absorbed overheads on a machine hour basis. It makes two products, Product A and Product B.
| Product A | Product B | |
|---|---|---|
| Direct material cost per unit | GH₵20 | GH₵60 |
| Direct labour cost per unit | GH₵50 | GH₵40 |
| Machine time per unit | 3 hours | 4 hours |
| Annual production | 6,000 units | 4,000 units |
Required:
(a) Calculate the product cost for each of the two products on the assumption the firm continues to absorb overhead costs on a machine hour basis.
The company is considering changing to an activity based costing (ABC) system and has identified the following information:
| Product A | Product B | |
|---|---|---|
| Number of setups | 18 | 32 |
| Number of purchase orders | 48 | 112 |
| Overhead cost analysis | GH₵ |
|---|---|
| Machine-related overhead costs | 204,000 |
| Setup related overhead costs | 280,000 |
| Purchasing-related overhead costs | 332,000 |
| Total production overheads | 816,000 |
Required:
(b) Calculate the unit cost for each of the two products on the assumption that the firm changes to an ABC system, using whatever assumptions you consider appropriate.
(c) Suggest how ABC analysis could be useful for measuring performance and improving profitability.
Answer
(a)
| Budgeted production overheads | GH₵816,000 |
|---|---|
| Budgeted machine hours | |
| Product A: 6,000 × 3 | 18,000 |
| Product B: 4,000 × 4 | 16,000 |
| Total budgeted machine hours | 34,000 |
Absorption rate per machine hour = GH₵816,000 / 34,000 hours = GH₵24
| Product A | Product B | |
|---|---|---|
| Direct materials | 20.0 | 60.0 |
| Direct labour | 50.0 | 40.0 |
| Production overhead | ||
| 3 hours/4 hours × GH₵24 | 72.0 | 96.0 |
| Full production cost per unit | 142.0 | 196.0 |
(B) Machine-related overhead costs:
Overhead cost per machine hour = GH₵204,000 / 34,000 hours = GH₵6 per machine hour
Setup related overhead costs:
Overhead cost per set up = GH₵280,000 / (18 + 32) = GH₵5,600 per set up.
Purchasing-related overhead costs:
Cost per purchase order = GH₵332,000 / (48 + 112) = GH₵2,075 per order.
| Product A | Product B | |||
|---|---|---|---|---|
| Total cost | Cost/unit | Total cost | Cost/unit | |
| Overheads: | GH₵ | GH₵ | GH₵ | GH₵ |
| Machine-related | ||||
| 18,000 × 6 | 108,000 | 18.0 | ||
| 16,000 × 6 | 96,000 | 24.0 | ||
| Set-up related | ||||
| 18 × 5,600 | 100,800 | 16.8 | ||
| 32 × 5,600 | 179,200 | 44.8 | ||
| Purchasing-related | ||||
| 48 × 2,075 | 99,600 | 16.6 | ||
| 112 × 2,075 | 232,400 | 58.1 | ||
| 308,400 | 51.4 | 507,600 | 126.9 |
Unit costs
| Product A | Product B | |
|---|---|---|
| Direct materials | 20.0 | 60.0 |
| Direct labour | 50.0 | 40.0 |
| Overheads | 51.4 | 126.9 |
| Total | 121.4 | 226.9 |
(c) ABC analysis could be used by MCC to analyse the profitability of Products A and B. Using ABC, the overhead cost per unit of B is much higher than with traditional absorption costing, and the cost per unit of A is less. This is because Product B has a relatively large amount of setup activity and purchasing-related activity.
Management could look at the reasons why Product B needs so many setups and purchase orders, and by trying to reduce the resources used up by these activities, it might be possible to reduce the costs (and increase the profitability) of Product B.
- Topic: Activity-based costing
- Uploader: Salamat Hamid