Question

1. ABC versus Traditional Costing

Dodo Co. manufactures three products, A, B & C. Data for the period just ended is as follows:

	A	B	C
Output (units)	20000	25000	2000
Sales price	$20	$20	$20
Direct material	$5	$10	$10
Direct Labour Hours per unit	2 hrs.	1 hr.	1 hr.
Direct Labour Wages @ $5 /hour)	$10	$5	$5

The following data on overhead costs incurred is now available:

Activities		$
Machining		55000
Quality control & set ups		90000
Receiving		30000
Packing		15000
Total		190000
Actual activities as per product.
Product	A		B		C
Output (units)	20000		25000		2000
Cost driver data:
Labour hours/unit	2		1		1
Machine hours/unit	2		2		2
No. of production runs	10		13		2
No. of components receipts	10		10		2
No. of customer orders	20		20		20

1. Using traditional absorption costing (using direct labour hours to apportion O/H), calculate the full production cost per unit and the profit per unit for each product.         
2. Using Activity Based Costing, calculate the full production cost and the profit per unit of each product.

Explain briefly how activity based costing may help OSCC management make better business decision(s).

Answer 1

1) Using traditional costing: Statement showing product cost per unit

Particulars	Product A	Product B	Product C
Direct Material cost Per unit	$5	$10	$10
Direct Labour Cost per unit	$10	$5	$5
Overhead cost per unit (Working note)	$5.672	$2.836	$2.836
Total cost per unit	$20.672	$717.836	$17.836

Working Note - Determination of overhead cost per unit
Total overhead costs = $190000
Total Labour Hours = Sum of (No of hours used in one unit of each product * no of units of each product)
= (2 * 20000) + (1 * 25000) + ( 1 * 2000)
=67000 hours

Overhead cost per hour = Total overhead costs / Total Labour Hours
=2.836 Aprox
Overhead cost per unit = Overhead cost per hour * No of labour hours used in each product
For Product A = 2.836 * 2
=5.672
For Product B = 2.836 * 1
= 2.836
For Product C = 2.836 * 1
=2.836

Statement Showing profit per unit

Particulars	Product A	Product B	Product C
Sales Price per unit (A)	$20	$20	$20
Less: Product cost per unit (B)	$20.672	$17.836	$17.836
Profit per unit (A-B)	($0.672)	$2.164	$2.164

2) b) Working notes: Statement showing cost activity cost pools and related cost driver rate/ unit

Activity Cost Pool	Related Cost Drivers	Total Overhead cost	Total Cost driver	Cost driver rate per unit
Machining	Machine hours per unit	55000	(2*20000)+ (2*25000) + (2*2000) = 94000	0.585
Quality Control and setuos	Production runs	90000	10*20000 + 13*25000 + 2*2000 =529000	0.170
Receiving	No. of component receipts	30000	10*20000 + 10*25000+ 2*2000 = 454000	0.066
Packaging	No of customer orders	15000	20*20000+ 20*25000 + 20*2000 = 940000	0.016

Using Activity Based Costing:- Statement showing product cost per unit

Particulars	Product A	Product B	Product C
Direct Material cost Per unit	$5	$10	$10
Direct Labour Cost per unit	$10	$5	$5
Machining	$1.17	$1.17	$1.17
Quality control and setups	$1.7	$2.22	$0.34
Receiving	$0.66	$0.66	$0.132
Packaging	0.32	0.32	0.32
Total cost per unit	18.85	19.37	16.962

Statement showing Proffit per unit

Particulars	Product A	Product B	Product C
Sales Price per unit (A)	$20	$20	$20
Less: Product cost per unit (B)	$18.85	$19.37	$16.962
Profit per unit (A-B)	$1.15	$0.63	$3.038

Activity based costing may help OSCC management make better business decisions in following ways:-

1. ABC along with some other cost management techniques can be utilized to improve performance and profitability of an organisation.

2. Wholesale distributors can gain significant advantage in the decision making process through implementation of ABC concepts by correlating costs to various activity. Introduction of new product or vendor can be better decided through ABC.

3. ABC can assist in decisions related to facility and resource expansion. Often the basis for relocation or opening of a new distribution center is based on cost associations. Reduction in freight or other logistics cost can offset the expense of the new facility, staff or equipment. The ABC model can identify the specific cost elements being targeted, providing a much clearer picture from which management can act.

4. Decision support for human resources can be augmented by ABC. Where activity, and therefore cost, can be associated to an individual, new levels of financial performance can be determined. This might be appropriate in cases of branch management or sales.

5. Companies who wish to determine price based on cost plus markup basis find ABC method of costing very relevant and are able to determine competitive prices for their products.