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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

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?

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