Activity Based Costing

Revision
Question 01
You have been assigned to examine the application the principles of ABC to four products currently
made and sold by your company. Details of the four products and relevant information are given below
for one period:

Product A B C D
Output in units 120 100 80 120
Costs per unit: $ $ $ $
Direct material 40 50 30 60
Direct labour 28 21 14 21
Machine hours (per unit) 4 3 2 3

The four products are similar and are usually produced in production runs of 20 units and sold in batches
of 10 units.

The production overhead is currently absorbed by using a machine hour rate, and the total of the
production overhead for the period has been analyzed as follows:

Machine department costs (rent, business rates, depreciation and $10430

supervision)
Set-up costs $5250
Stores receiving $3600
Inspection/quality control $2100
Materials handling and dispatch $4620

You have ascertained that the ‘cost drivers’ to be used are as listed below for the overhead costs shown:

Costs Costs driver

Set up costs Number of production runs
Storage receiving Requisitions raised
Inspection/quality control Number of production runs
Materials handling and dispatch Orders executed

The number of requisitions raised on the stores was 20 for each product and the number of orders
executed was 42, each order being for a batch of 10 of a product.

You are required:

a. To calculate the total costs for each product if all overhead costs are absorbed on a machine
hour basis;
b. To calculate the total costs for each product, using activity-based costing;
c. To calculate and list the unit product costs from your figures in (a) and (b) above, to show the
differences and to comment briefly on any conclusions which may be drawn which could have
pricing and profit implications.

1
Question 02
W is a manufacturing company that produces three products: X, Y and Z. each uses the same resources,
but in different quantities as shown in the table of budgeted data for 2018 below:

Product X Y Z
Budgeted production 1500 2500 4000
Direct labour hours per unit 2 4 3
Machine hours per unit 3 2 3
Batch size 50 100 500
Machine setups per batch 2 3 1
Purchase orders per batch 4 4 6
Material movements per batch 10 5 4

W’s budgeted production overhead cost for 2018 are $400000 and current practice is to absorb these
costs into product costs using an absorption rate based on direct labour hours. As a result the
production overhead cost attributed to each product unit is:

Product X $32
Product Y $64
Product Z $48

The management of W is are considering changing to an activity based method of attributing overhead
costs to products and as a result have identified the following cost drivers and related cost pools:

Cost pool $ Cost driver

Machine maintenance 100000 Machine hours
Machine setups 70000 Machine setups
Purchasing 90000 Purchase orders
Material handling 60000 Material movements

The remaining $80000 of overhead costs are caused by a number of different factors and activities that
are mainly labour related and are to be attributed to products on the basis of labour hours.

Required:
Calculate the production overhead cost attributed to each product unit using an activity based
approach.