Question

Kota Mills supply Divine Denim with the organic denim used in their production. After discussions with Helen about the service she was getting from Good Numbers, the manager of Kota Mills decided to use Good Numbers to assist with their management decision making. Kota Mills produces three different weights of denim using two departments. In Department 1, machines weave the cloth. In Department 2 the cloth is dyed a variety of colours. Information for the combined use of resources in both departments for the three types of fabric is outlined below.

Bolts are 20 metres each. All fabric is inspected during production. Robotic equipment inspects the fabric for obvious flaws as the bolts are wound up. Each bolt spends about 5 minutes in the inspection process.

Denim

8 ounce13 ounce16 ounceTotalunitsMonthly production in units (bolts of fabric) 1,000 4,000 2,000 7,000boltsDirect material cost $ 8,000 24,000 20,000 52,000$Direct labour cost $ 660 1,320 920 2,900$Direct labour hours 33 66 46 145hoursMachine hours 500 1,333 1,500 3,333hoursNumber of set-ups for dye colour changes 10 30 20 60set-upsInspection time 83 333 167 583hours

Combined overhead costs for the two departments follow:

Cost to operate and maintain machines $ 40,000Set-up costs $ 11,000Inspection costs $ 6,996Total $ 57,996

Previously, Kota Mills used a costing system focused on processes. It allocated direct materials to each product separately but allocated direct labour and conversion costs as if they were incurred equally across the units produced. Under this costing system, the overhead cost for Department 1 is $19,332 and for Department 2 it is $38,664. Direct labour hours and costs in Department 1 are 55 hours at $1,100, and the remaining are in Department 2. Direct materials for Department 1 are $15,000 for 16 ounce denim, $16,000 for 13 ounce denim, and $6,000 for 8 ounce denim. The remaining direct materials are added in Department 2. No beginning or ending inventory or abnormal spoilage is recorded for Kota Mills this period.

Required:

Set up a spreadsheet to perform the calculations in ii. and iii. below. Use a data input section and cell referencing.

Use conventional process costing to allocate the direct materials and conversion costs per department to total bolts produced. Develop a cost per bolt for each type of fabric. (Hint: You will need to first calculate the equivalent cost per bolt for conversion costs for each department.)

Using activity-based costing (ABC), develop a cost per bolt.

Compare the process costing and ABC results. Identify the products with overstated costs and those with understated costs. Explain why the costs are misstated under traditional process costing.

How could the Kota Mills manager use the ABC information to improve operations? (max 200 words) (3 marks

Answer 1

Statement of Level of Activity
Particulars	8 ounce	13 ounce	16 ounce	Total
Labour Hours	33	66	46	145
Machine Hours	500	1333	1500	3333
No. of Set Ups	10	30	20	60
Inspection Time	83	333	167	583
Statement of Cost Pools
Cost Drivers / Activity	Total Costs (A)	Allocation Base	Level of Allocation Base (B)	Activity Rates (C=A/B)
Cost to operate & maintaining machine	40000	Machine Hours	3333	12.00
Set up Costs	11000	No.of Set Ups	60	183.33
Inspection Costs	6996	Inspection time	583	12.00
Particulars	Activity Incurred	Overhead Assigned
8 ounce	13 ounce	16 ounce	8 ounce	13 ounce	16 ounce
Cost to Operate & Maintaining Machine	500	1333	1500	0	0	0
Set Up Costs	10	30	20	0	0	0
Inspection Costs	83	333	167	0	0	0
				0	0	0
Note: Overhead Assigned = Activity Rates * respective activity incurred
Statement of Product Costing (As per ABC Analysis)
Particulars	8 ounce	13 ounce	16 ounce	Total
Material	8000	24000	20000	52000
Direct labor	660	1320	920	2900
Overheads	8829	25492	23671	57992
Total Cost (A)	17489	50812	44591	112892
Volume (B)	1000	4000	2000	7000
Cost Per Bolt (A/B)	17.49	12.70	22.30	16.13
Statement of Costs as per Traditional Methos
Particulars	Department 1	Department 2	Total
Overhead Cost	19332	38664	57996
Direct Labor Cost	1100	1800	2900
Direct Material
16 ounce	15000	5000	20000
13 ounce	16000	8000	24000
8 ounce	6000	2000	8000
Total	57432	55464	112896
Direct Labour Hours	55	90	145
ABC Information to improve Operations
Bolts with higher contributions to be produced