Question

2. The following comparative data is provided for the Laventura Boating Company. It is stated that the company has more accurate product cost information using activity-based costing to allocate overhead.

Laventura Boating Company

(Direct Labour hours as allocation base)

	Fish Boat $	Luxury Boat $
Direct Materials	32,000	41,600
Direct Labour	19,200	24,000
Overhead*	40,960	51.200
Total Production cost per unit (a)	92,160	116,800
Sales Prices (b)	102,400	144,000
Profit = (b) – (a)	10,240	27,200

Activity Based Costing

(Several different allocation bases)

	Fish Boat $	Luxury Boat $
Direct Materials	32,000	41,600
Direct Labour	19,200	24,000
Overhead*	32,128	95,360
Total Production cost per unit (a)	83,328	160,960
Sales Prices (b)	102,400	144,000
Profit = (b) – (a)	19,072	(16,960)

b. Explain why the overhead cost is so different using activity-based costing. Type in order for me to copy and paste

c. List 2 possible decisions that management might take due to the significant change in relative profitability of the two types of boats resulting from the use

of ABC. Type in order for me to copy and paste

d. Activity-based costing undoubtedly provides better cost information than most traditional costing methods, such as plant wide and department allocation methods. However, ABC has its limitations. What are the advantages and disadvantages of using activity-based costing? Type in order for me to copy and paste

Answer 1

b)

• Overhead cost is so different in ABC method mainly due to the activities consumed.
• Overhead allocated to Luxury boat is more in ABC costing due to the more consumption of activities
• Traditional costing system allocates overhead based on labor hours hence it does not reflect actual activities consumed cost

c) 2 possible decisions that management might take

• Increase selling price of Luxury Boat to make it profitable
• Reduce cost of Luxury boat by reviewing the activities consumed for its production

d) ABC Costing system should be used because it has advantages. Below are the listed advantages

• It helps in accurate product costing and taking reliable decisions
• It helps in decision making like Product level profitability, launch of new products, customer level cost analysis, etc
• It helps in accurate Product pricing
• It helps in better cost management through cost control and cost reduction

Disadvantages of ABC Costing System

• ABC costing method is time consuming since it needs identification of activities and calculating activity cost driver rates
• It needs specialized knowledge to apply the ABC costing method throughout the organisation
• ABC method is not useful if cost is more than benefits involved in implementing it