Question

The following information provides details of the cost, volume and cost drivers for the particular period in respect of ABC & Co. Products X Y Z Total Production and sales (units) 30,000 20,000 8,000 Raw material usage (units) 5 5 11 Direct material cost GHS 25 GHS 20 GHS 11 GHS 1,238,000 Direct labour hours 1⅓ 2 1 88,000 Machine hours 1⅓ 1 2 76,000 Direct labour cost 8 12 6 Number of production run 3 7 20 30 Number of deliveries 9 3 20 32 Number of receipts 15 35 220 270 Number of production orders 15 10 25 50 Overhead Cost: GHS Set-up 30,000 Machines 760,000 Receiving 435,000 Packing 250,000 Engineering 373,000 1,848,000 In the past the company has allocated overhead to products on the basis of direct labour hours. However, the majority of overheads are more closely related to machine hours than direct labour hours. The company has recently redesigned its cost system by recovering overheads using two volume-related bases: machine hours and material handling overhead rate for recovering overheads of the receiving department. Both the current and previous cost system reported low profit margin for product X, which is the company’s highest selling product. The management accountant has recently attended a conference on activity-based costing and the overhead cost for the last period have been analysed by major activities in order to compute activity-based costs. Required: 3 (a) Compute the product cost using a traditional volume-related costing system based on the assumptions that: i. All overheads are recovered on the basis of direct labour hours ii. The overheads of the receiving department are recovered by a material handling overhead rate and the remaining overheads are recovered using a machine hour rate. (b) Compute product costs using an activity-based costing system.

Answer 1

(a) (i) COMPUTATION OF PRODUCT COSTS USING TRADITIONAL COSTING SYSTEM (based on assumption that all overheads are recovered on the basis of Direct Labour hours)

Direct labour hour rate = GHS 1,848,000 / 88,000 hours = GHS 21 per hour.

Products	X	Y	Z
	GHS	GHS	GHS
Direct Labour	8.00	12.00	6.00
Direct Materials	25.00	20.00	11.00
Over head [4/3 x 21, 2 x 21; 1 x 21]	28.00	42.00	21.00
Total	61.00	74.00	38.00

(ii) The overheads of the receiving deptt. are recovered by a material handling overhead rate the remaining overheads are recovered by using a machine hour rate:

Material handling rate = Receiving overhead cost / Direct material cost = GHS 435,000 / GHS 1,238,000 = 35.14%

Machine hour rate = GHS (1,848,000 - 435,000) / 76,000 hours = GHS 18.59

Products	X	Y	Z
	GHS	GHS	GHS
Direct Labour	8.00	12.00	6.00
Direct Materials	25.00	20.00	11.00
Material handling overhead [25 x 35.14%, 20 x 35.14%, 11 x 35.14%]	8.79	7.03	3.87
Other Over head [4/3 x 18.59, 1 x 18.59, 2 x 18.59]	24.79	18.59	37.18
Total	66.58	57.62	58.05

(b) COMPUTATION OF PRODUCT COSTS USING ACTIVITY BASED COSTING (ABC) SYSTEM:

Machine overhead rate per hour = GHS 760,000 / 76,000 hours = GHS 10

Cost per set-up = GHS 30,000 / 30 production runs = GHS 1,000

Cost per receiving order = GHS 435,000 / 270 receipts = GHS 1,611.11

Cost per packing order = GHS 250,000 / 32 deliveries = GHS 7,812.50

Engineering cost per production order = GHS 373,000 / 50 orders = GHS 7,460

Products	X	Y	Z
	GHS	GHS	GHS
Production and sales (units)	30,000	20,000	8,000
Direct Labour	8.00	12.00	6.00
Direct Materials	25.00	20.00	11.00
Machine Overheads [4/3 x 10, 1 x 10, 2 x 10]	13.33	10.00	20.00
Set-up costs [(1,000 x 3) / 30000, (1,000 x 7) / 20,00, (1,000 x 20) / 8000]	0.10	0.35	2.50
Receiving [(1,611.11 x 15) / 30000, (1,611.11 x 35) / 20,000, (1611.11 x 220) / 8000]	0.81	2.82	44.31
Packing [(7,812.5 x 9) / 30000, (7,812.5 x 3) / 20000, (7,812.5 x 20) / 8000]	2.34	1.17	19.53
Engineering [(7,460 x 15) / 30000, (7,460 x 10) / 20000, (7,460 x 25) / 8000]	3.73	3.73	23.31
Total	53.31	50.07	126.65