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(ABC Costing) Curren Ltd currently uses absorption costing. The following costings have been prepared using direct...

(ABC Costing)

Curren Ltd currently uses absorption costing. The following costings have been prepared using direct labour hours as a base for recovering overhead.

Products	B421 €	B437 €	B449 €	B457 €
Direct costs	4.28	5.19	9.02	11.48
Production overheads	5.06	3.13	4.01	5.34
Production cost	9.34	8.32	13.03	16.82
Selling price	8.80	11.50	18.00	17.50
Profit/loss	(0.54)	3.18	4.97	0.68

The management are currently reviewing the cost accounting policy in relation to overheads and are considering the implementation of an activity based costing system.

The management accountant has done an activity analysis and divided the overhead cost into the following cost pools and drivers:

Cost Pools Cost drivers

Raw material handling €28,025 number of material requisitions

Machine set-up costs €34,400 number of set up hours

Machine related costs €203,298 number of machine hours

Quality checks €70,488 number of inspections

Finishing and dispatch costs €51,510 number of items

The following information is also available;

Products	B421	B437	B449	B457
Sales/production units	36,000	18,900	22,500	8,450
Number of units per batch	2,000	900	900	650
Material requisitions per batch	4	4	4	3
*Hours per machine set-up	4 hours	3 hours	2 hours	5 hours
Machine hours per batch	15 hours	12 hours	14 hours	17 hours
Quality tests per batch	7 tests	4 tests	5 tests	6 tests

*You can assume that the machinery is set up for each batch.

Requirement

Calculate the cost and profit per unit of the four products using activity-based costing.
The production manager is an advocate of the introduction of ABC and has said that ‘all companies should adopt it as it will give the true cost of the products produced’.

Your CEO (not a management accountant) is not sure and has asked you to write a brief business memo where you compare the costs and profits for the four products with absorption costing giving possible reasons for the differences between both systems and critically comment on the production managers’ statement.

Expert Solution

Computation of Activity Cost Drivers
	B421	B437	B449	B457	Total
Number of material requisitions	72	84	100	39	295
Number of setup hours	72	63	50	65	250
Number of machine hours	270	252	350	221	1,093
Number of inspections	126	84	125	78	413
Number of units	36,000	18,900	22,500	8,450	85,850

Computation of Overhead Rate for each Activity
Activity Cost Pool	Overhead	Cost Driver	Activity	Overhead Rate
Raw material handling	€ 28,025	Number of material requisitions	295	€ 95.00
Machine set-up costs	€ 34,400	Number of setup hours	250	€ 137.60
Machine related cost	€ 203,298	Number of machine hours	1,093	€ 186.00
Quality checks	€ 70,488	Number of inspections	413	€ 170.67
Finishing and dispatch costs	€ 51,510	Number of units	85,850	€ 0.60

Curren Ltd
ABC Costing Income Statement
	B421	B437	B449	B457	Total
Sales	€ 316,800.00	€ 217,350.00	€ 405,000.00	€ 147,875.00	€ 1,087,025.00

Direct Costs	€ 154,080.00	€ 98,091.00	€ 202,950.00	€ 97,006.00	€ 552,127.00
Production Overheads
Raw material handling costs	€ 6,840.00	€ 7,980.00	€ 9,500.00	€ 3,705.00	€ 28,025.00
Machine set-up costs	€ 9,907.20	€ 8,668.80	€ 6,880.00	€ 8,944.00	€ 34,400.00
Machine related cost	€ 50,220.00	€ 46,872.00	€ 65,100.00	€ 41,106.00	€ 203,298.00
Quality checks costs	€ 21,504.81	€ 14,336.54	€ 21,334.14	€ 13,312.50	€ 70,488.00
Finishing and dispatch costs	€ 21,600.00	€ 11,340.00	€ 13,500.00	€ 5,070.00	€ 51,510.00
Total Production Overheads	€ 110,072.01	€ 89,197.34	€ 116,314.14	€ 72,137.50	€ 387,721.00
Total Costs	€ 264,152.01	€ 187,288.34	€ 319,264.14	€ 169,143.50	€ 939,848.00
Profit	€ 52,647.99	€ 30,061.66	€ 85,735.86	(€ 21,268.50)	€ 147,177.00
Profit/(Loss) per unit	€ 1.46	€ 1.59	€ 3.81	(€ 2.52)

Working Notes
Computation of Activity Cost Drivers
	B421	B437	B449	B457
Total Units Sold/Produced	36,000.0	18,900.0	22,500.0	8,450.0
Units per Batch	2,000.0	900.0	900.0	650.0
Number of Batches	18.0	21.0	25.0	13.0

	B421	B437	B449	B457
Number of Batches	18.00	21.00	25.00	13.00
Material Requisitions per batch	4.00	4.00	4.00	3.00
Number of material requisitions	72.00	84.00	100.00	39.00

	B421	B437	B449	B457
Number of Batches	18.00	21.00	25.00	13.00
Hours per machine set-up	4.00	3.00	2.00	5.00
Number of setup hours	72.00	63.00	50.00	65.00

	B421	B437	B449	B457
Number of Batches	18.00	21.00	25.00	13.00
Machine hours per Batch	15.00	12.00	14.00	17.00
Number of machine hours	270.00	252.00	350.00	221.00

	B421	B437	B449	B457
Number of Batches	18.00	21.00	25.00	13.00
Quality tests per Batch	7.00	4.00	5.00	6.00
Number of inspections	126.00	84.00	125.00	78.00

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