QUESTION

You are just from attending a conference on Activity Based Costing (ABC) and you now wish to put your knowledge to practice by applying the principles of ABC to the four products currently made and sold by your client. Details of the four products and relevant information are given below for one period.

Product A B C D

Output in units 120 100 80 120

Costs per unit K K K K

Direct materials 40 50 30 60

Direct labour 28 21 14 21

Machine hours (per unit) 4 3 2 3

The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows:

K

Machine department costs (rent, business rates, depreciation and supervision) 10,430

Set-up costs 5,250

Stores receiving 3,600

Inspection/quality control 2,100

Materials handling and dispatch 4,620

You have ascertained that the cost drivers to be used are as listed below for the overhead costs shown:

Cost Cost driver

Set-up costs Number of production runs

Stores receiving Requisitions raised

Inspection/quality control Number of production runs

Materials handling and dispatch Orders executed

The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 42, each order being for a batch of 10 of a product.

Required:

1. Calculate the total production cost per unit of each product using absorption costing

1. Calculate the total production cost per unit of each product using activity-based costing
2. Based on the unit product costs calculated above, show the differences and comment briefly on any conclusions which may be drawn which could have pricing and profit implications.

Briefly explain five (5) circumstances which call for the application of ABC as opposed to absorption costing.