Question

1. Firm XYZ has fixed indirect costs of £100,000,000. The firm produces 1,000,000 units of product ABC. Additionally, for each unit produced, £50 of variable indirect costs are also incurred. Further, each unit produced consumes 2 direct labour hours, 5 machine hours and £20 of direct materials. The cost of 1 labour hour is £12.50 and it costs £5 per hour to run the machines. The firm also manufactures other products. In total it spends £75,000,000 on direct labour and £125,000,000 on running the machines. ABC can be sold in the market at a price of £130 per unit.

1. What is the per unit cost of product ABC according to the absorption costing approach, assuming that half of the relevant indirect costs are allocated with reference to the cost of direct labour and the other half with reference to the cost of running the machines? Would you recommend for the firm to produce ABC when calculating the cost of ABC in this way?

This is all the information provided.

Answer 1

W.N1 - Total Labour hours = Total units * labour hour per unit = 10,00,000 * 2 = 20,00,000 Labour hours

W.N2 - Total Machine hours = Total unnits * machine hours per unit = 10,00,000 * 5 = 50,00,000 Machine hours

W.N3 Labour cost per hour = Fixed cost / Total labour hours = 5,00,00,000 / 20,00,000 =25 / Labour hour

W.N4 Macine hour rate per hour = fixed cost / Total machine hours = 5,00,00,000 / 50,00,000 = 10 / Machine hour

Statement showing cost per unit.

Variable cost		Amount
Direct material cost	20*1	20.00
Direct labour cost	12.5*2	25
Direct machine cost	5*5	25
Indirect variable cost	50*1	50
		120.00
Fixed cost
Indirect labour cost	25*2	50
Indirect machine cost	10*5	50
		100
Cost per unit		220.00

As selling price is 130& unit cost per unit is 220, I will not suggest company to find cost per unit this way.