Question 2: Activity-based costing

Yak Products Ltd manufactures two products. The company uses a traditional costing system where only manufacturing overhead cost is allocated to products. Manufacturing overhead cost is allocated to products using a predetermined plant-wide overhead rate based on direct labour hours. The company is investigating the possibility of introducing an activity-based costing system. Preliminary work has been completed based on the information for the year ending 31 December 2020. You are presented with the following information for the year ending 31 December 2020:

• The predetermined manufacturing overhead rate was calculated based on:
• estimated manufacturing overhead cost: $9,425,000.
• estimated total direct labour hours: 725,000 hours.
• Direct material cost is $7,000,000 for Product A and $6,000,000 for Product B.
• 50,000 units of Product A were produced and sold. Each unit requires 10 direct labour hours at a cost of $20 per hour.
• 15,000 units of Product B were produced and sold. Each unit requires 15 direct labour hours at a cost of $20 per hour.
• Product A is sold for $750 per unit and Product B is sold for $1,000 per unit.
• General expenses are $5,250,000 and marketing expenses are $1,750,000.

Activity-based costing information

A number of cost pools have been identified. The following tables show the allocation of costs (manufacturing overhead costs and non-manufacturing overhead costs) between departments. They also show how management intends to allocate the total overhead cost to the identified cost pools.

Table 1: Summary of departmental overhead costs

	$	$
Manufacturing department
Indirect material	3,000,000
Indirect labour	3,625,000
Factory equipment depreciation	1,850,000
Other factory-related costs	950,000	9,425,000
General administrative department
Wages and salaries	3,250,000
Other expenses	2,000,000	5,250,000
Marketing department
Salaries and wages	650,000
Selling expenses	1,100,000	1,750,000

Table 2: Suggested allocation of overhead costs

	Activity cost pools
	Customer orders	Automated machinery	Finishing	Product design	Customer relations	Other
Manufacturing department
Indirect material		0.6	0.4
Indirect labour	0.03	0.03	0.7	0.2	0.04
Factory equipment depreciation		0.75	0.15	0.1
Other factory-related costs	0.2	0.4	0.2	0.1		0.1
General administrative department
Wages and salaries	0.1			0.2	0.2	0.5
Other expenses	0.1				0.2	0.7
Marketing department
Salaries and wages	0.5		0.1	0.2	0.2
Selling expenses	0.1				0.9

Additional information

• Product A does not require any new design resources. 50,000 units were manufactured from 1,500 individual orders. Each unit requires 5 machine hours.
• Product B contains some custom-made features and therefore requires design resources. 500 designs were completed during the year. 15,000 units were manufactured from 1,500 individual orders. Each unit requires 20 machine hours.
• It was decided not to allocate any costs associated with customer-level activities (customer relations) or organisation-sustaining activities (other overheads) to products. Direct material cost and direct labour cost are traced to products.
• All direct labour is incurred in the finishing department.

The following table shows the cost drivers for each activity cost pool:

Table 3: Cost drivers

Activity cost pool	Activity
Customer orders	Orders
Automated machinery	Machine hours
Finishing	Labour hours
Product design	Designs
Customer relations	Not applicable
Other	Not applicable

Tasks

1. Prepare a profit statement, using traditional costing principles. Show the per-unit cost for both products.
2. Using the information from Tables 1 and 2, allocate the overhead cost to each activity cost pool.
3. Using your answer from Question 2(b) and Table 3, calculate the activity rate for each activity cost pool. Round your numbers to two decimal places.
4. Calculate the total overhead cost for each product using activity-based costing principles. Round your activity costs to whole numbers.
5. Prepare a profit statement, using activity-based costing principles. Show the per-unit cost for both products (note: rounding will create some differences in the reported net profits ignore these differences).
6. Indicate whether the activity-based costing information benefits Yak Ltd.s analysis of the product costs for Product A and Product B. Provide reasons to support your answer.