Question

ABC Limited makes three products; A, B and C. Details of product direct costs and volumes for the period are as follows:

Product	A	B	C
Direct material cost per unit	£5.00	£4.50	£12.50
Direct labour cost per unit	£9.00	£18.00	£27.00
Labour hours per unit	1 hours	2 hours	3 hours
Machine hours per unit	3 hours	6 hours	9 hours
Production volumes for period	3,500	750	750

Total production overheads for the period are £362,500.

ABC Ltd currently recovers overheads on a labour hour basis.

The Finance Director (FD) feels that the current method of recovering overheads is outdated and wishes to consider the application of Activity Based Costing (ABC).                                          

The FD has provided you with the following information.

The breakdown of production overheads between activities for the period is as follows:

Activities	% of total overheads
Set up costs	15
Machinery costs	25
Quality Inspections	15
Ordering	10
Labour related costs	35
Total	100

You have the following statistical data about the cost drivers of each activity for the period:

Cost driver	A	B	C
Number of set ups	25	15	5
Machine hours	See data above
Number of inspections	75	25	50
Number of orders	30	15	15
Labour hours	See data above

Required:

Calculate the total unit cost of the three products using labour hours to recover overheads.

Calculate the total unit cost of the three products using Activity Based Costing.

List two advantages and two disadvantages of Activity Based Costing.

Answer 1

Answer 1: considering labour hours as proxy for overheads for each unit of production

Overhead cost allocated to A= 362500 *(1*3500) /( 1*3500+2*750+3*750) =175000 pounds

Per unit overhead cost for A=50 pounds

Overhead cost allocated to B= 362500 *(2*750) /( 1*3500+2*750+3*750) =75000 pounds

Per unit overhead costs for B=100 pounds

Overhead cost allocated to C= 362500 *(3*750) /( 1*3500+2*750+3*750) = 112375 pounds

Per unit overhead costs =149.83 pounds

Per unit total cost as follows:

Product	Direct material	direct labour	Overhead	Unit cost total(pounds)
A	5	9	50	63
B	4.5	18	100	122.50
C	12.5	27	149.83	189.33

ABC costing:

First of all we shall allocate the overhead cost to the cost pool categories . Total overhead =362500 pounds

Activities	% of overhead	Overhead cost	# units driving cost	Cost /unit	Costs for A	Costs for B	Costs for C
Set up costs	15%	=0.15*362500=54375	=25+15+5=45	1208.33	=25*1208.33=30208.25	=15*1208.33=18124.95	=5*1208.33=6041.65
Machinery cost	25%	=0.25*362500=90625	=3*3500+6*750+9*750=21750	4.17	=10500*4.17=43785	=4500*4.17=18765	=6750*4.17=28147.5
Quality inspections	15%	=0.15*362500=54375	=75+25+50=150	362.5	=75*362.5=27187.5	=25*362.5=9062.5	=50*362.5=18125
Ordering	10%	=0.1*362500=36250	=30+15+15=60	604.17	=30*604.17=18125.10	=15*604.17=9062.55	=15*604.17=9062.55
Labour related costs	35%	=0.35*362500=126875	=1*3500+2*750+3*750=7250	17.5	=3500*17.5=61250	=1500*17.5=26250	=2250*17.5=39375
Total					180555.85	81265	100751.7

As per ABC costing,total cost allocated to A as per table is 180555.85 pounds. Therefore per unit overhead cost =180555.85/3500 = 51.59 pounds

Similarly unit overhead cost for B = 81265/750 =108.35 pounds

Unit overhead cost for C = =100751.71/750= 134.34 pounds

Therefore as per ABC costing unit costs are as follows:

Product	Direct material	Direct labour	Overhead	Total unit cost(pounds)
A	5	9	51.59	65.59
B	4.5	18	108.35	130.85
C	12.5	27	134.34	173.84

Answer 2: ABC costing needs more information and is more difficult to implement. They encompass multiple activity costs rather than a platwide overhead rate.They are not suitable for external reports.They may allocate period costs as well.