THIS EXAMPLES ARE ADAPTED FROM

Cost and Management Accounting

(1996)
Prentice Hall
ISBN 0-13-205923-1

Chairs
Cost Items
A
B
Sales and production (units)
300
Raw materials usage (units)
35
Direct materials cost ($/unit)
$ 22.75 $
Direct labour hours (hour/unit)
5
Direct labour cost ($/unit)
$ 67.50 $
Machine hours (hour/unit)
4
Number of production runs (runs/total
6
Number of deliveries (deliveries/total
3
Number of receipts (receipts/total uni
4
Number of production orders (order/tot
2

C
100
20
13.00 $
6
81.00 $
2
2
5
4
5

50
40
26.00
3
40.50
5
1
10
1
10

Total area in warehouse (ft2)

15000

10000

Overhead costs
Set up
Machines
Receiving
Packing
Engineering
Insurance
Utilities
Total

25000

$
5,000
6,500
6,500
8,500
6,500
4,500
15,500
53,000

Total
450
14,500
$ 9,425.00
2,250
$ 30,375.00
1,650
9
18
9
17
50,000

1. Calculate the labour hour rate. In this case, we will consider that
Total overhead ($)
Number of hours
Labour rate ($/hour)
2. Calculate cost per unit
Cost
Direct materials ($/unit)
Direct labor ($/unit)
Overhead ($/unit)
Cost/unit

53000
2250
23.55556

A
22.75
67.5

C
13
81

26
40.5

117.7778 141.3333 70.66667

208.028 235.333 137.167

we will consider that overhead cost are absorbed on a labor hour basis

300
35
22.75
5
4
67.5
6
3
4
2

Products
B
100
20
13
6
2
81
2
5
4
5

5000

2500

A
Sales and production (units)
Raw materials usage (units)
Direct materials cost ($/unit)
Direct labour hours (hour/unit)
Machine hours (hour/unit)
Direct labour cost ($/unit)
Number of production runs (runs/total units)
Number of deliveries (deliveries/total units)
Number of receipts (receipts/total units)
Number of production orders (order/total units)
Total area in warehouse (ft2)
Overhead costs
Set up
Machines
Receiving
Packing
Engineering
Total

$
5000
6500
6500
8500
6500
53000

roducts
C

Total
50
40
26
3
5
40.5
1
10
1
10

450
95
9425
2250
1650
30375
9
18
9
17

1500

9,000

1. Select activities to absorb overhead. Thi method is transit

In this case, two activities are selected to absorb overhead
~Paperwork handling based on number of orders, engineering
~Other overhead based on machine usage

2. Calculate the distributing basis for each case

Material handling rate. This is based on the number of receipts
Number of orders
17
Total cost of Scheduling
6500
Cost of each order ($/order)
382.3529
Other overhead rate. This is calculated considering machine used
Other overheads
Number of machine hours
Other overhead rate ($/hour)

46500
1650
28.18182

3. Now we calculate the unit cost based on previous calculat

A
Direct material
22.75
Direct labour
67.5
Overhead from Scheduling
2.54902
Other overhead
112.7273
Unit cost
205.526

ad. Thi method is transition from traditional to ABC method

absorb overhead
f orders, engineering

r each case
n the number of receipts

d considering machine used hours. The previous overhead must be substracted

sed on previous calculations

B
C
13
26
81
40.5
19.11765 76.47059
56.36364 140.9091
169.481
283.88

A
Sales and production (units)
Raw materials usage (units)
Direct materials cost ($/unit)
Direct labour hours (hour/unit)
Machine hours (hour/unit)
Direct labour cost ($/unit)
Number of production runs (runs/total units)
Number of deliveries (deliveries/total units)
Number of receipts (receipts/total units)
Number of production orders (order/total units)
Total area in warehouse (ft )
2

Overhead costs
Set up
Machines
Receiving
Packing
Engineering
Insurance
Utilities
Total

Products
B
300
100
35
20
22.75
13
5
6
4
2
67.5
81
6
2
3
5
4
4
2

25000

15000

$
5,000.00
6,500.00
6,500.00
8,500.00
6,500.00
4,500.00
15,500.00
53,000.00

oducts
C

Total
50
40
26
3
5
40.5
1
10
1

450
14500
9425
2250
1650
30375
9
18
9

10

17

10000

50000

1. Identify cost drivers

trace cost of inputs into cost pools
trace cost of pools into product costs
Cost pools
Driver Value of driver
Machine usage
Hour rate
$
3.9
Set ups
cost/set up
$ 555.6
Receiving
cost/receive
$ 722.2
Packaging
cost/package
$ 472.2
Orders
cost/order
$ 382.4
2
Insurance
cost/ft
$
0.1
Utilities
Overhead cost
Machine
Set up cost
Receiving cost
Packaging cost
Orders Cost
Insurance cost
Utilities cost
Total overhead

cost/ft2

$
A
15.76
11.11
9.63
4.72
2.55
7.50
25.83
77.10

0.3
B
7.88
11.11
28.89
23.61
19.12
13.50
46.50
150.61

C
19.70
11.11
14.44
94.44
76.47
18.00
62.00
296.17

2. Calculate cost per unit

Cost
A
B
C
Direct materials
22.75
13.00
26.00
Direct labor
67.50
81.00
40.50
Overhead
77.10 150.61 296.17
Unit cost
167.35
244.61 362.67

Unit cost
Direct Method
Multiple allocation method
ABC

A
208.03
205.53
167.35

B
235.33
169.48
244.61

C
137.17
283.88
362.67

Overhead
Direct Method
Multiple allocation method
ABC

A
117.78
115.28
77.10

B
141.33
75.48
150.61

C
70.67
217.38
296.17

Overhead as a % of total cost

Direct Method
Multiple allocation method
ABC

B
57%
56%
46%

C
60%
45%
62%

52%
77%
82%

1. Conclusions
ABC helps to visualize that product C is absorbing a large amount of overhead
Direct method is based on labor and does not give any information on how
Mutiple allocation method is a good approximation of ABC results
Overhead is increasing, labor could be only 5% to 10% of total cost

overhead