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CP CMA 2 Answer 2011-07-18

CP CMA 2 Answer 2011-07-18

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MODULE 1 Solution 2 Abkaber plc (a) (i) Labour hours Total overhead cost = $12,000,000 Total labour hours

= 500,000 hours Overhead per labour hour = $12,000,000/500,000 = $24

COSTING METHODS

(ii)

Activity Based Costing Deliveries to retailers $2,400,000/250 = $9,600 Set-ups $6,000,000/100 = $60,000 Deliveries inwards $3,600,000/800 = $4,500

23rd & 24th 10 Kaplan CP – Notes – CMA

182

Copyright© Kaplan Financial 2010

Notwithstanding the fact that labour is a relatively minor cost. The major reason for the difference appears to be that while labour hours are not all that significant for Fireball production.000. however. but this should also be a linear relationship (i. however. the use of labour hours to allocate overheads magnifies its importance. Moreover.000 but using ABC it makes a loss of $182. It thus attempts to identify a series of cause and effect relationships. These problems include: 23rd & 24th 10 Kaplan CP – Notes – CMA 183 Copyright© Kaplan Financial 2010 . ABC and labour hours cost allocation ABC attempts to allocate overheads using a number of cost drivers rather than just one as with labour hours. If the Fireball model is to continue.MODULE 1 (b) REPORT – ABKABER PLC To: From: Subject: Date: (i) Direct costs Directors of Abkaber plc Management Accountant The Introduction of Activity Based Costing December 2002 COSTING METHODS The direct costs of labour and materials are unaffected by the use of ABC as they are directly attributable to units of output. The Marketing Director The marketing director suggests that ABC may have a number of problems and its conclusions should not be believed unquestioningly. maintaining a wide product range and raising the reputation of the motorcycles. whether there is a cause and effect relationship between overheads and labour hours.g. There may.e. While costs are likely to be caused by multiple factors. The contrast between the labour hours costing system and ABC can be seen in requirement (a). which may increase sales of other models. The central concern is. deliveries and purchase processes. the accuracy of any ABC system will depend on both the number of factors selected and the appropriateness of each of these activities as a driver for costs. e. however. be other non-financial reasons to maintain the Fireball. a review of the assembly and distribution systems may be needed in order to reduce costs. the low volumes of Fireball sales cause a relatively high amount of set-ups. As noted already there should ideally be a direct cause and effect relationship between the cost driver and the relevant overhead cost pool. Each cost driver should be appropriate to the pool of overheads to which it relates. (ii) The Finance Director Using the labour hours method of allocation the Fireball makes an overall profit of $520. those in favour of ABC argue that it is activities that generate costs. to the extent it affects the conclusions on the Fireball’s viability. The labour hours allocation basis As labour appears to be paid at a constant rate an allocation using labour cost or labour hours gives the same result. This seems unlikely on the basis of the information available. Moreover for this allocation base to be correct overheads would need to be linearly variable with labour hours. These differences can be brought out by reviewing the comments of the directors. There is thus a significant difference in the levels of cost allocated and in profitability between the two methods. and this is recognised by ABC. costs increase proportionately with the number of activities operated). not labour hours.

improve by $182. then a decision could be taken to cease Fireball production as it generates a negative contribution of $182. The Managing Director (1) ABC normally assumes that the cost per activity is constant as the number of times the activity is repeated increases. (2) The use of ABC for one-off decisions can be distinguished from its use in normal. Depreciation on the factory building might be one example. (4) As with labour hours allocations it is the future that matters. and thus do not fall easily under ABC as a method of cost attribution as there is no cause and effect relationship. such that costs per activity are non linear. While ABC may be closer to this concept than a labour hours allocation basis. a number of qualifications to this statement: (1) If the company carried stock then the method of cost allocation would. (3) The MD is correct in stating that some costs do not vary with either labour hours or any cost driver. In practice there may be a learning curve. – Increased and on-going analysis work – Continued evaluation of cause and effect relationships between cost drivers and cost pools.MODULE 1 COSTING METHODS (1) For decisions such as the closure of Fireball production or the pricing of the new motorbike rental contract. in this case. In these circumstances the introduction of ABC in normal costing procedures may have restricted benefits. (2) If the ABC information can be relied upon. Further Issues The following should also be considered in evaluating ABC: – The need to develop new data capture systems. its accuracy depends upon identifying appropriate cost drivers. affect stock values and thus would influence profit. There are. (3) There may be interdependencies between both costs and revenues that ABC is unlikely to capture. however. thus by the introduction of ABC and the subsequent closure decision profits would. fixed costs are included which would also mean that the marginal cost does not equal the average cost. what is really needed is the incremental cost to determine a break-even position. ongoing costing procedures.180. the marginal cost of increasing the number of activities is not the same as the average. an incremental costing analysis would be undertaken for important one-off decisions such as the closure of Fireball production or the pricing of the new motorbike rental contract. Where costs are truly common to more than one product then this may be difficult to capture by any given single activity. and the relevant costs of doing so. in the short term at least. notwithstanding the above qualifications. The Chairman From a narrow perspective of reporting profit it is true that the two methods give the same overall profit as is illustrated in requirement (a) at $4.000. Any relationship between costs and activities based upon historic experience and observation may be unreliable as a guide to the future.000. It is perfectly possible that while labour hours may have been used for normal costing. all other things being equal. (2) Also. 23rd & 24th 10 Kaplan CP – Notes – CMA 184 Copyright© Kaplan Financial 2010 . As a result.000. This was not apparent from the use of labour hours.

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