Question

Explain the difference in gross profit for Home and Work when switching from Traditional costing to and ABC Costing system. Since sell price is the same in both, the real answer is how cost of each product shifts when switching from traditional to ABC system. The cost per unit numbers are laid out below to make it easier to see the pertinent information.

                           Home               Work

                          Cost/unit         Cost/unit

Traditional        $191.83          $267.80

ABC                    $$168.99        $307.76

Please use the concept of activity proportions to answer the question: Explain how/why the cost of each product shifted when switching from a traditional system to an ABC system.

Answer 1

• Activity-based costing (ABC) is a costing technique that assigns overhead and indirect costs to the related products and services. The ABC Costing recognizes the relationship between costs, overhead activities, and manufactured products, thereby assigning indirect costs to products.
• Under activity-based costing, an activity pool is the set of all activities necessary for completing a task.  ABC identifies activity units that drive costs for each pool.

• When each product's activity pool cost totals, the cost per unit is calculated. To find product unit costs, the activity pool cost totals are divided by the number of product units.

• In the given question, the cost per unit changed when switched from traditional costing approach to ABC Costing, since under ABC Costing, costs are allocated on the basis of activity pools such as Number of setups, Number of batch runs, etc.

• The cost of each product shifted when switching from a traditional system to an ABC system because ABC finds different indirect (overhead) costs per unit for each product. ABC results are thus unlike the traditional costing , where indirect costs per unit remains same.

• Activity-based costing treats overhead costs essentially as direct costs, the cost estimates reflect actual cost driver usage for each product. These costs, are therefore, apportioned to individual product units.
• In traditional cost accounting (production volume-based allocation), an accurate measure of total overhead cost is accessible. However, in conventional costing the distribution of that total to individual products is based on an indirect measure of that cost.