Question

Cost Accounting Ltd manufactures three products. The company allocates overhead costs as a rate per total direct labour hour.

The following cost driver values have been identified:

Machine hours / unit Production units Percentage of expert work Number of orders packed Labour hours

Alpha

0.70 5 000 30% 4
1 200

Beta

0.30 3 500 20% 8 800

Gamma

0.50 8 000 50% 23 1 500

An analysis of the manufacturing overhead cost for the period shows the following:

Activities

Machine costs Expert consultation Packing
Total

Overhead cost

265 000 98 500 15 000

378 500

Required		Marks
7.1	Calculate the overhead rate that they are currently applying to the products.	1.5
7.2	Allocate the manufacturing overhead costs using principles of activity based costing.	12
7.3	Why is activity based costing considered for manufacturing overhead cost allocation?

Answer 1

	Machine hours M	Production units P	Machine used M*P	% of expert work	No. of orders packed	Labor Hours
Alpha	0.7	5000	3500	30%	4	1200
Beta	0.3	3500	1050	20%	8	800
Gamma	0.5	8000	4000	50%	23	1500
Total		16500	8550		35	3500
Ans 7.1
Overhead rate
Estimated overhead/No of direct labor hours
395000/3500	112.86	per DLH
Ans 7.2				Alpha		Beta		Gamma
	Estimated cost	Cost driver	Rate per driver	Activity	Cost allocated	Activity	Cost allocated	Activity	Cost allocated
Machine Cost	$265,000	8550	$30.99	3500	$108,480	1050	$32,544	4000	$123,977
expert Consultation	98500	100	$985.00	30	$29,550	20%	$19,700	50%	$49,250
Packing	15000	35	$428.57	4	$1,714	8	$3,429	23	$9,857
	$378,500			Total cost	$139,744		$55,672		$183,084
				allocated
	Manufacturing overhead allocated
Alpha	$139,744
Beta	$55,672
Gamma	$183,084
ans 7.3

Activity based costing identifies different cost pool and activities associated with it and allocates cost on this basis, so this gives accurate allocation of cost to products and increases the traceability of the cost to the product or services. In other words ABC costing assigns factory/manufacturing overhead based on the activities identified and assigning cost to those activities according to the actual consumption by each activity. If cost is wrongly traced the product or services can be under priced or over priced which can affect the sales volume and customers. Hence there can be loss of customers in case of over price and loss of revenue in case of under price. So when proper cost is assigned to each activity than we are able to know which cost is in control and which cost is going out of control. So those cost which are increasing we could fix up the responsibility to those handling that and we could take steps to control the cost.