Question

Tuka Pty limited is a company based in Lusaka that was started 20 years ago by two brothers. The company manufactures four similar products produced on the same production machinery.

The company has been undergoing a drop in profits in recent years due to increased completion in the sector in which the company operates. At a recent board meeting, the board chairman suggested that the company may be losing business to its competitors due to inaccurate product cost information that management is using to set product prices. As such, he has suggested that the company considers the introduction of Activity Based Costing to assist management in improving its product pricing systems.

The company uses a profit margin of 20%, to price its products.

In order to facilitate the change in costing systems, the cost Accountant has collected the following information related to the four products for the previous period:

​​​​​​A​​B​​C​​D​​

Budgeted total units for period​​240​​200​​160​​240

Number of production runs​​​12​​10​​8​​12

Number of stores requisitions raised​​40​​40​​40​​40

Number of sales orders received​​24​​20​​16​​24

Materials cost per unit​​​​K50​​K60​​K40​​K70

Labour cost per unit​​​​K38​​31​​K24​​K31

Machine hours per unit​​​4​​3​​2​​3

The production overheads are currently absorbed using a machine hour rate, and the total of the production overheads for the last period have been analysed as follows:

Activity​​​​​Total cost​​Cost driver

​​​​​​   K

Machine related activities​​​20,800​​​Machine hours

Set up costs​​​​​10,500​​​Number of production runs

Stores receiving​​​​7,500​​​Requisitions raised

Inspection​​​​​4,500​​​Number of production runs

Material handling and dispatch​​8,200​​​Orders executed

Required:

(a) Calculate the selling prices for the four products using the current system of accounting for overheads that was in use in the last period.

(10marks)

(b) Calculate the selling prices for the four products if an Activity Based Costing system was the system in use.​​​​​​​(10 marks)

(c) Advise management whether they should change to an Activity Based costing system based on your answers in (a) and (b) above.​​​

(d) List four factors that should be taken into account both internal as well as external in a decision to adopt an Activity based costing system.​​​

(e) Explain the factors that should be considered when selecting a cost driver.

​​​​​​​​​​

(f) Explain three potential benefits and three potential problems that may arise as a result of a change from the current system to an Activity based costing system.​

Answer 1

A	Particulars	A	B	C	D
	Materials cost per unit	12,000	12,000	6,400	16,800
	Labour cost per unit​	9,120	6,200	3,840	7,440
	Machine rate	7,680	4,800	2,560	5,760
	Other cost 30700	11,335	7,085	3,778	8,502
	Total cost	40,135	30,085	16,578	38,502
	PROFIT	8,027	6,017	3,316	7,700
	Selling price	167	150	104	160
b	ABC COSTING
	Particulars	A	B	C	D
	Budgeted total units for period	240	200	160	240	840
	Number of production runs	12	10	8	12	42
	Number of stores requisitions raised	40	40	40	40	160
	Number of sales orders received	24	20	16	24	84
	Materials cost per unit	50	60	40	70	220
	Labour cost per unit​	38	31	24	31
	Machine hours per unit	4	3	2	3
	Total machine hours	960	600	320	720	2600
	Machine related activities	20,800	Machine Hour	8.00
	Set up costs	10,500	​Number of production runs	250.00
	Stores Receiving	7,500	Stores	46.88
	Inspection	4500	Number of production runs	107.14
	Material handling and dispatch	8200	Orders executed	97.62
		A	B	C	D
	Materials cost per unit	12,000.00	12,000.00	6,400.00	16,800.00
	Labour cost per unit​	9,120.00	6,200.00	3,840.00	7,440.00
	Machine rate	7,680.00	4,800.00	2,560.00	5,760.00
	Set up costs	3,000.00	2,500.00	2,000.00	3,000.00
	Stores Receiving	1,875.00	1,875.00	1,875.00	1,875.00
	Inspection	1,285.71	1,071.43	857.14	1,285.71
	Material handling and dispatch	2,342.86	1,952.38	1,561.90	2,342.86
		37,303.57	30,398.81	19,094.05	38,503.57
	No of units	240	200	160	240
	Cost per unit	155.43	151.99	119.34	160.43
	Profit	31.09	30.40	23.87	32.09
	Selling price	186.52	182.39	143.21	192.52

C. Co should follow Abc costing

d.

Cost structure

Indirect cost allocation

Each product price and profit

External market conditions etc

e.

Activity based Costing or ABC is the cost drivers are the important factors which contributes to the various cost heads like labor, maintenance and so on.

It is generally used to distribute the total overhead costs to the produced units in a given time.

The factors, which are responsible for selecting the cost drivers, are, labor hours used, machine hours, customer contacts, quantity of goods returned and so on.

Factors for selecting activity cost drivers are as follows;

1. You need to determine the cost of the object this to ensure better distribution of the cost of a target.

2. You need to investigate the important cost drivers to ensure the relationship between the specified activity and the cost incurred.

3. Management control effect

f.

Advantages of Activity-Based Costing

Provides realistic costs of manufacturing for specific products

Allocates manufacturing overhead more accurately to products and processes that use the activity

Identifies inefficient processes and target for improvements

Determines product profit margins more precisely

Discovers which processes have unnecessary and wasted costs

Offers better understanding and justification of costs in manufacturing overhead

Disadvantages of Activity-Based Costing

Collection and preparation of data is time-consuming

Costs more to accumulate and analyze information

Source data isn't always readily available from normal accounting reports

Reports from ABC don't always conform to generally accepted accounting principles and can't be used for external reporting

Data produced by ABC may conflict with managerial performance standards previously established from traditional costing methods

May not be as useful for companies where overhead is small in proportion to total operating costs

ABC produces more accurate costing of products by essentially converting broad indirect costs into direct costs of production. It determines the costs of the various sources of indirect costs and allocates these expenses to the specific activities that use them.

Setting up an ABC system is time-consuming and expensive to maintain, but it provides management with valuable information that can be used to improve the efficiency of processes and increase product profit margins.