Question
Mangal Murti Plastics Limited is currently using a traditional two-stage cost allocation system. In the first stage, all factory-overheads are allocated to two production departments,
Mangal Murti Plastics Limited is currently using a traditional two-stage cost allocation system. In the first stage, all factory-overheads are allocated to two production departments, A and B, based on machine hours; while the second stage uses direct labor hours for absorption of these overheads to individual products Regular and Deluxe.
During September 2020, Mangal Murti Plastics Limited had a total factory overhead cost of Rs. 10 lakhs. The number of machine-hours used in the Production Departments A and B were 40,000 and 1,60,000 respectively. The number of direct labor-hours in Production Departments A and B were 20,000 and 10,000 respectively.
The following information relates to products deluxe and regular for the month of September 2020:
Stage #1 Allocation: (Based on Machine Hours)
(Rs. in lakhs)
Total Factory Overheads during September 2020 Rs. 10.00
Total Overheads Allocated to Production DeptA (Rs. 10(4/20)) Rs. 2.00
Total Overheads Allocated to Production DeptB (Rs. 10(16/20)) Rs. 8.00
Stage #2 Allocation: (Rs. in lakhs)
Total Overheads Allocated to Production Department A Rs. 2.00
Labor-Hours in Department A during September 2020 20,000 hours.
Therefore, Labor-Hour Absorption Rate of Department A is (Rs. 2 lakhs/20,000 hours) = Rs. 10.
Total Overheads Allocated to Production Department B Rs. 8.00
Labor-Hours in Department B during September 2015 10,000 hours.
Therefore, Labor-Hour Absorption Rate of Department B is (Rs. 8 lakhs/10,000 hours) = Rs. 80.
Cost Sheet for the month of September 2020
| Particulars | Deluxe | Regular | ||
| Units Produced and Sold | 2,000 | 8,000 | ||
|
| Total (Rs. in lakhs) | Per Unit (Rs.) | Total (Rs. in lakhs) | Per Unit (Rs.) |
| Direct Material Cost | Rs.2.00 | Rs. 100.00 | Rs. 4.00 | Rs. 50.00 |
| Direct Labor Cost | Rs. 1.50 | Rs. 75.00 | Rs. 4.80 | Rs. 60.00 |
| PRIME COST | Rs. 3.50 | Rs. 175.00 | Rs. 8.80 | Rs. 110.00 |
| Factory Overheads: |
|
|
|
|
| Department A (Absorption rate @ Rs. 10 per labor hour) | Rs. 0.40 | Rs. 20.00 | Rs. 1.60 | Rs. 20.00 |
| Department B (Absorption rate @ Rs. 80 per labor hou r) | Rs. 1.60 | Rs. 80.00 | Rs. 6.40 | Rs. 80.00 |
| TOTAL COST | Rs. 5.50 | Rs. 275.00 | Rs. 16.80 | Rs. 210.00 |
| Profit | Rs. 1.00 | Rs. 50.00 | Rs. 1.20 | Rs. 15.00 |
| SALES | Rs. 6.50 | Rs. 325.00 | Rs. 18.00 | Rs. 225.00 |
Other information collected for the month of September 2020:
- Break-up of Factory Overheads
(Rs. in lakhs)
- Material Receipt and Movement Costs Rs. 0.70
- Production Setup Cost Rs. 6.00
- Inspection and Quality Check cost Rs. 3.00
- Shipment Cost Rs. 0.30
Total Factory Overheads for September, 2020 Rs. 10.00
- Some non-financial information collected for the month of September 2020:
| Particulars | Deluxe | Regular |
| 50 | 100 |
| 150 | 200 |
| 4 | 6 |
| 25 | 50 |
| 2,000 | 8,000 |
Do you believe that the traditional system of allocating factory overheads is providing the management better and more reliable cost information about the products for better decision making. Answer this question with proper analysis/reasoning.
If no, then find the cost per unit and thereby profit per unit for Deluxe as well as for Regular by using some alternative and better system (Activity-Based Costing) of allocating overheads using the given information and give your observations and comments for the same.
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