Question

Hoffman Ltd makes two types of portable cooking stove, the Lightweight (LW) and the Megarange (MR). Last year it produced 4,500 LWs and 500 MRs. The direct materials cost £3.00 for one LW and £10 for one MR. The assembly workers who put the stoves together are all paid at the same rate of £6.30 an hour. When LWs are being produced each operative assembles nine stoves an hour and when MRS are being produced each operative assembles seven stoves an hour. This is the only labour that is classed as ‘direct labour’. The factory uses automated machinery to manufacture the components which are common to both stoves. The other components are bought in. Each stove uses 15 machine hours in its construction. It currently uses an absorption costing system but is considering introducing an activity-based costing system. The current overhead absorption rate is based upon machine hours. Last year’s activities have been analysed as follows: Activity Cost driver Activity Cost pool Purchasing Purchase order 20,000 Training Training hour 1,000 Setting up machines No. of set-ups 2,250 Running machines Machine hours 14,250 Total 37,500 The analysis also quantified the number of cost drivers by each stove: Activity No of cost drivers caused by LWs No of cost drivers caused by MRs Purchasing 360 40 Training 20 30 Setting up machines 60 30 Running machines 67,500 7,500 Tasks: 1. Calculate the absorption cost for each type of stove. 2. Calculate the activity-based cost for each type of stove.

Answer 1

1. Absorption rate = 37,500/75,000

=0.5

	LWs	MRs
Direct Material	3.00	10.00
Direct Labor	0.70	0.90
Overhead	7.50	7.50
Absorption Cost	11.20	18.40

2.

Activity	Cost Driver	Amount	Total Usage	Per Cost Driver	LWs	MRs
Purchasing	Purchase Order	20,000.00	400.00	50.00	18,000.00	2,000.00
Training	Training Hour	1,000.00	50.00	20.00	400.00	600.00
Setting up Machines	No of Set ups	2,250.00	90.00	25.00	1,500.00	750.00
Running Machines	Machine Hours	14,250.00	75,000.00	0.19	12,825.00	1,425.00
		37,500.00			32,725.00	4,775.00
Number of Units	4,500.00	500.00
Per unit Overhad	7.27	9.55

	LWs	MRs
Direct Material	3.00	10.00
Direct Labor	0.70	0.90
Overhead	7.27	9.55
Absorption Cost	10.97	20.45