(ABC Costing)

Curren Ltd currently uses absorption costing. The following costings have been prepared using direct labour hours as a base for recovering overhead.

Products	B421	B437	B449	B457
Direct costs	4.28	5.19	9.02	11.48
Production overheads	5.06	3.13	4.01	5.34
Production cost	9.34	8.32	13.03	16.82
Selling price	8.80	11.50	18.00	17.50
Profit/loss	(0.54)	3.18	4.97	0.68

The management are currently reviewing the cost accounting policy in relation to overheads and are considering the implementation of an activity based costing system.

The management accountant has done an activity analysis and divided the overhead cost into the following cost pools and drivers:

Cost Pools Cost drivers

Raw material handling 28,025 number of material requisitions

Machine set-up costs 34,400 number of set up hours

Machine related costs 203,298 number of machine hours

Quality checks 70,488 number of inspections

Finishing and dispatch costs 51,510 number of items

The following information is also available;

Products	B421	B437	B449	B457
Sales/production units	36,000	18,900	22,500	8,450
Number of units per batch	2,000	900	900	650
Material requisitions per batch	4	4	4	3
*Hours per machine set-up	4 hours	3 hours	2 hours	5 hours
Machine hours per batch	15 hours	12 hours	14 hours	17 hours
Quality tests per batch	7 tests	4 tests	5 tests	6 tests

*You can assume that the machinery is set up for each batch.

Requirement

1. Calculate the cost and profit per unit of the four products using activity-based costing. (60 marks)
2. The production manager is an advocate of the introduction of ABC and has said that all companies should adopt it as it will give the true cost of the products produced.

Your CEO (not a management accountant) is not sure and has asked you to write a brief business memo where you compare the costs and profits for the four products with absorption costing giving possible reasons for the differences between both systems and critically comment on the production managers statement.