Application of Activity-Based Costing

Nina Audrey started Nina Interiors, a niche furniture brand, 10 years ago. She ran the business as a sole proprietorship. While she has 50 skilled carpenters and 5 sales people on her payroll, she has been taking care of the accounting by herself. Now, she intends to offer 40% of the ownership to public in next couple years and is willing to make changes and has hired Tracy as a management accountant to organize and improve the accounting systems.

Nina Interior's total budgeted manufacturing overheads cost for the current year is Ugx 111,240,000 and budgeted total labor hours are 20,000. Alison the financial accountant has been applying traditional costing method during the whole 10 years period.

Nina Interior's sofas includes the 2-set, 3-set and 6-set options. State House recently placed an order for 150 units of the 6-set type. The order is expected to be delivered in one-month time. Since it is a customized order, State House will be billed at cost plus 25%.

Tracy is not a fan of traditional costing system. She believes that the benefits of activity-based costing system exceeds its costs, so Tracy has sat down with Aaron Mason, the chief engineer, to identify the activities which the firm undertakes in its sofa division.

Next, Tracy calculated the total cost that goes into each activity, identified the cost driver that is most relevant to each activity and calculated the activity rates.

The results are summarized below:

Activity	Amount (Ugx)	Relevant Cost Driver	Activity level
Production of components	20,310,000	Machine hours	25,000
Assembly of components	15,200,000	Number of labor hours	20,000
Packaging	2,130,000	Units	5,000
Shipping	6,000,000	Units	5,000
Setup costs	3,4000,000	Number of setups	240
Designing	1,200,000	Designer hours	1,000
Product testing	2,400,000	Testing hours	500

Once the order was ready for packaging, Alison gave you a summary of total cost incurred, and a statement of activities performed (also called the bill of activities) as shown below:

Order No: 1502021 Customer: State House Units: 150 Type: 6 Set
Cost of direct materials		Ugx 15,000,000
Cost of purchased components		Ugx 13,500,000
Labor cost		Ugx 11,560,000
Activity	Relevant Cost Driver	Activity Usage
Production of components	Machine hours	320
Assembly of components	Number of labor hours	250
Packaging	Units	150
Shipping	Units	150
Setup costs	Number of setups	15
Designing	Designer hours	70
Product testing	Testing hours	22

Required;

Help management of Nina interiors to calculate the total costs using activity-based costing.

Why would Tracy prefer Activity-based costing rather than the Traditional costing method?

Are there limitations to the traditional costing method?