6. Activity based costing.

Apollo plc manufactures and sells several products, two of which are
Alpha and Beta.
a. Estimated data for the two products for the forthcoming period is as follows:
Product data Alpha Beta Other products
Production/sales units 5,000 10,000 40,000
P000 P000 P000
Total direct material cost 80 300 2,020
Total direct labour cost 40 100 660
b. Variable overhead cost is P1,500,000 of which 40 percent is related to the acquisition, storage
and use of direct materials and the remainder is related to the control and use of direct labour.
c. It is current practice for Apollo plc to absorb the two types of variable overhead cost to
products using an overall company-wide percentage based on either direct material cost and
direct labor cost as appropriate.
d. Apollo are considering the use of activity-based costing. The drivers for material and labor
related overheads have been identified as follows:
Alpha Beta Other products
Weight of material/unit 4 1 1.5
Labour operations/unit 6 1 2
Direct material related overhead-cost driver is weight of material
Direct labour related overhead-cost driver is number of labour operations
e. Market investment indicated that market prices for Alpha and Beta of P75 and P95 per unit
respectively will achieve the estimated sales shown in (a) above.
f. Apollo plc requires a minimum estimated contribution/sales ration of 40 percent before
proceeding with the production or sale of any product.
Required:
1. Prepare estimated unit product costs for Alpha and Beta where the variable overhead is
charged to product units as follows:
a. using the existing absorption rates as detailed above,
b. using an activity-based costing approach
2. Using the information in (1) prepare an analysis that will help Apollo determine whether both
Alpha and Beta should remain in production.
Answer:
1.a.
Material related overhead cost (40% of P1.5m) = P600,000

P600,000
Overhead absorption rate ___________________ x 100 = 25% of direct material cost
P2,400,000

Labour related overhead cost (60% of P1.5m) = P900,000

P900,000
Overhead absorption rate _______________ x 100 = 112.5% of direct labour cost
P800,000

Alpha Beta
P P
Direct materials 16 30
Direct Labour 8 10
Prime cost 24 40
Material related overhead (25%) 4 7.5
Labour related overhead (112.5%) 9 11.25
Total variable costs 37 58.75

b.
Alpha Beta Other
Production units 5,000 10,000 40,000
Weight of direct material (kg) 4 1 1.5
Total weight of material (kg) 20,000 10,000 60,000

P600,000
Mat. Related overhead/kg _______________________ = P6.67/kg
20,000 + 10,000 + 60,000

Alpha Beta Other

Production units 5,000 10,000 40,000
Labour operation/unit 6 1 2
Total operations 30,000 10,000 80,000

P900,000
Lab. related overhead/op ________________________ = P7.50 per operation
30,000 + 10,000 + 80,000
 Unit costs based on ABC Alpha Beta
P P
Direct materials 16 30
Direct labour 8 10
Prime cost 24 40
Material related overhead 26.68 6.67
Labour related overheads 45 7.50
Total variable costs 95.68 54.17

2.
Alpha Beta
Traditional ABC Traditional ABC
P P P P
Direct material 16 16 30 30
Direct labour 8 8 10 10
Material related overhead 4 26.68 7.50 6.67
Labour related overhead 9 45 11.25 7.50
Total variable cost 37 95.68 58.75 54.17
Selling price 75 75.00 95.00 95.00
Contribution/unit 38 (20.68) 36.25 40.83
C/S ratio 51% (28)% 38% 43%

Apollo plc require a minimum C/S ratio of 40 per cent. If product costs are determined
using the traditional methods Apollo would decide to proceed with the production of Alpha (C/S
ratio of 51 per cent) and reject Beta which has a C/S just below the required 40 per cent.
If ABC is used the decision will be reversed. Alpha will be rejected on the basis of a
negative C/S ratio and Apollo will proceed with Beta which has a C/S ratio of 43 per cent.
ABC provides a more accurate cost of products unlike the traditional method used, which
is a broad-based averaging of costs. ABC attempts to reflect the true consumption of resources.