Question

What is a job-order costing system? What do you know about Activity-Based-Costing (ABC) system? What are the differences between an ABC system and a traditional costing system? Use an example to show how we calculate and allocate overhead costs in an ABC system and a traditional system.

Answer 1

Job order costing system is a system of costing that is used to assign and accumulate costs od an individual unit of cost. This system s used in a case when items produced are sufficiently different from each other and everyone have a significant cost.The job cost record reports direct materials and direct labor and assigned amount of manufacturing overhead of each item that were used.

An activity based costing system is an method that is used to find the total cost of activities that is necessary for making a product. Under ABC costing each activity is assigned cost( that goes into production).It is generally used as a tool for understanding product cost and profit that is based on production.

Difference between an ABC system and a traditional costing system are:

ABC system	Traditional system
It is a complex system	It is a simple system
In this the cost id dependent upon the activities that is used by the cost objects	Under this cost object and used up resources are required for cost evaluation.
This is more preferred than Traditional system	This is less preferred than ABC system.
This uses multiple overhead pools	This uses a single overhead pool
This system focus on activities.	This focus on structure.
This is largely in use since 1981.	This is almost obsolete.

For example:

A company makes 2 types of ball one with hollow center and one with solid center. The equipment used is same During the year company expects to make 1,000,000 hollow center ball and 2,000,000 solid center ball. The overhead cost allocated to the activity pool are as:

Materials purchased	$200,000
Set up of machines	350,280
Packaging	300,000
Testing	270,000
Cleaning and maintenance	288,540
Total overhead cost	$1,408,820

The cost driver estimated and cost calculated are:

Activity	cost driver	total expected unit	total cost	unit cost per cost driver
purchasing of material	purchase order	100	$200,000	$2,000
Set up of machines	set up	252	$350,280	$1,390
packaging	containers filled	2,500,000	300,000	0.12
testing	test	3,000	270,000	90
cleaning and maintenance	of runs	252	288,540	1,145

The activity by product is as follows:

Activity	Cost driver	unit cost (3)	Expected use hollow Centre (4)	expected use solid Centre (5)	ABC cost assigned Hollow Centre (6)	ABC cost assigned solid Centre (7)
Purchasing purchase orders		$2,000	50	50	$100,000	$100,000
set up	set ups	1,390	126	126	175,140	175,140
Packaging	containers filled	0.12	500,000	2,000,000	60,000	240,000
Testing	tests	90	1,000	2,000	90,000	180,000
Cleaning and maintenance	runs	1,145	84	168	96,180	192,360
Total					$521,320	$887,500

Per unit overhead cost in ABC costing :

Hollow Centre ball = $521,320/1,000,000 = $0.521

Soft center ball = $887,500 / 2,000,000 = $0.444

Under traditional method based on direct labor . Estimated direct labor cost for the year = $1,512,000( hollow = $378,000 and soft = $1,134,000)

Per unit direct labor cost:

Hollow center = $378,000 / 1,000,000 = $0.38

Soft center = $1,134,000 / 2,000,000 = $0.57

Per unit cost of ball are :

Overhead per direct labor = $1,408,820 / $1,512,000 = $0.932

Allocation of overhead:

Hollow center = $0.932* $0.378 = $0.352 overhead per unit

Soft center = $0.932* $0.528 = $0.528 overhead per unit

Company overhead per unit :

	ABC	Traditional
Hollow center	$0.52	$0.35
Solid center	$0.44	$0.53