Question

Question 3                                                                                  (Total: 25 marks)

Sikawan Systems manufactures two products in its Sabah division. Traditionally the company has used an overhead absorption system based on machine hours. However, following a management consultancy exercise in which outside consultants reviewed the management information systems, the directors have decided to pilot an Activity Based Costing system at the Sabah division. For the coming year, 2021, Sabah’s production overheads are estimated as follows:

	RM
Factory rent and rates	42,200
Heat and light to factory	23,950
Factory insurance	7,100
Supervisory salaries	38,540
Other indirect labour	18,030
Canteen charges	6,100
Machinery depreciation	18,000
Machinery maintenance	5,520
Production consumable (e.g. machine oil)	2,050
Other factory costs	7,480
TOTAL	168,970

Following a detailed review of the production processes, the finance director and the divisional accountant identify a set of key cost drivers, together with cost allocations to each, and estimates of the relevant quantities involved for products A and B in the 2021 financial year:

Activity	Cost driver	Total	Product A	Product B	Total cost per cost driver RM
Planned units of production			6,000	5,000
Machining	Machine hours	11,000	6,000	5,000	63,030
Assembly	Labour hours	9,000	3,000	6,000	43,020
Packing	Labour hours	4,000	2,000	2,000	31,000
Materials ordering	No. of orders	111	86	25	9,990
Materials issues	No. of issues	150	103	47	12,000
Machine set up	No. of hours used in set up	33	25	8	5,940
Quality inspection	No. of inspection	35	10	25	3,990
TOTAL					168,970

Each planned unit of production of both product A and product B uses one machine hour. One unit of A has a prime cost of RM12.50, while one unit of B has a prime cost of RM16.

Required:

a) Calculate the overhead absorption rate based on the company’s traditional system of using machine hours as a basis for overhead absorption.                      

b) Calculate the overhead per unit of product A and product B using the data provided for the new Activity Based Costing system.                                          

c) Calculate the production cost of one unit of product A and one unit of product B under both the old and the new costing systems.                                     

d) Comment on the difference between the production costs for each product under the old and the new costing systems.                                             

Answer 1

a.

Overhead absorption rate Traditional system
Particulars
Total Production overhead	RM      168,970
Total production machine hours required
For A (6000 x1 hour)	6000
For B (5000 x1 hour)	5000
Total machine hours	11000
Overhead absorption rate per machine hour	RM          15.36

b.

Activity	Total cost	Cost driver	Cost per driver	Product A	Product B
Machining	RM        63,030	11000	RM              6	RM      34,380	RM 28,650
Assembly	RM        43,020	9000	RM              5	RM      14,340	RM 28,680
Packing	RM        31,000	4000	RM              8	RM      15,500	RM 15,500
Materials ordering	RM          9,990	111	RM            90	RM        7,740	RM   2,250
Materials issued	RM        12,000	150	RM            80	RM        8,240	RM   3,760
Machine set up	RM          5,940	33	RM          180	RM        4,500	RM   1,440
Quality inspection	RM          3,990	35	RM          114	RM        1,140	RM   2,850
Total Overhead cost	RM      85,840	RM 83,130

c.

	Traditional costing system	Activity based costing
Production cost	Product A	Product B	Product A	Product B
Prime cost	RM        75,000	RM       80,000	RM     75,000	RM      80,000
Add Overhead cost	RM        92,165	RM       76,805	RM     85,840	RM      83,130
Total Production cost	RM      167,165	RM    156,805	RM 160,840	RM    163,130
Number of units produced	6000	5000	6000	5000
Total Production cost per unit	RM          27.86	RM         31.36	RM       26.81	RM        32.63

d.

As we can see, following traditional system will result in higher per unit production cost for Product A and lower for Product B because under this method Product A is absorbing the overhead cost of Product B . But, ABC shows exactly opposite results as Product A results in lower cost as compared to Traditional system and Product B is alloted higher cost i.e. ABC results in proper cost allocation and independant product will absorb the cost that pertains to respective product.

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