Question

Question 2 [100 marks]

In Jasmine Ltd’s production cost centre, two units are produced: Unit Aand Unit B, the total overhead cost being €1000. This is made up of two costs:

1. Machine set-up costs of €800; and

2. Inspection costs of €200.

Overhead is absorbed on the basis of direct labour hours. The total direct labour hours (DLH) amount to 200 DLH.

1. Unit A requires 150 DLH; and

2. Unit B 50 DLH.

The machinery for Unit A only needs to be set-up once whereas Unit Brequires nine set-ups. Unit A and Unit B both require two inspections each.

Required

a) Calculate the overhead recovery charge that should be made to each product, based on:

1. Absorption costing method based on Direct Labour Hours.
   [20 marks]

2. The ABC method based on machine set-up costs and inspection costs.

   [50 marks]

b) Show the comparison of each method and write a short note explaining

why the difference occurs.

[30 marks]

Answer 1

Hey champ, here's your answer:

1. Overhead recovery charge that should be made to each product, based on:
Absorption costing method based on Direct Labour Hours.

The total overhead cost:
1	Machine setup cost	€ 800
2	Inspection cost	€ 200
	Total overhead cost	€ 1,000
Total direct labour hours =		200 DLH
Thus, Overhead absorption rate is
€ 1,000	/  200 DLH
=	€ 5 per DLH
We've got absorption rate, now we just have to muntiply the activity hours with absorption rate to calculate overhead recovery
UNIT	DIRECT LABOUR HOURS	Abs Rate	Overhead recovery
A	150	€ 5	€ 750
B	50	€ 5	€ 250

2. In ABC method of costing we do not recover overhead based on one blanket rate of overhead, instead overhead is recovered based on activity level. Thus overhead related to machine set-up is recovered based on number of machine setups in the both the units and so on. Thus,

Overhead cost related to machine setup
€            800
Total No. of Machine setups in unit A & unit B=
10 set-ups	( 1 setup for A + 9 Setup for B)
Thus, overhead absorption rate=
800 / 10=	80 per set ups
In the same way
Overhead cost related to Inspection
€            200
Total No. of Inspection in unit A & unit B=
4 Inspection	( 2 Inspection for A + 2 Inspection for B)
Thus, overhead absorption rate=
200 / 4=	50 per Inspection
We've got absorption rate, now we just have to muntiply the activity hours with absorption rate to calculate overhead recovery
UNIT	No of machine setup	Abs Rate	Overhead recovery
A	1	€                       80	€        80
B	9	€                       80	€      720
			€     800
UNIT	No of inspections	Abs Rate	Overhead recovery
A	2	€                       50	€      100
B	2	€                       50	€      100
			€     200
Thus total overhead recovered
Units	Machining Activity	Inspection activity	Total
A	€                                 80	€                     100	€      180
B	€                               720	€                     100	€      820

3. Summary of overhead recovery based on different methods:

Method	Overhead recovered
DLH	Unit A	€      750
	Unit B	€      250
ABC	Unit A	€      180
	Unit B	€      820

Thus, as seen above overhead recovery based on DLH does not give credit to unit A for less use of machine set ups.