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- 25 Marks
Question
Bonti Ltd produces three different products using two production departments. The company currently uses Absorption Costing to establish product costs and profitability. The Directors have recently attended a conference on Activity Based Costing (ABC) and are examining whether ABC might provide a better system for Bonti Ltd.
The following budgeted information for the period ended 31 December 2017 has been collated for each of the three products:
| Product | Taya | Maya | Paya |
|---|---|---|---|
| Production and Sales (units) | 8,750 | 4,000 | 6,000 |
| Unit sales price (GH¢) | 56 | 106 | 84 |
| Direct materials | 1.5kg | 6kg | 7kg |
| Direct labour: | |||
| – Machine Department (hours per unit) | 1 hour | 8 hours | 6 hours |
| – Assembly Department (hours per unit) | 4 hours | 3 hours | 1 hour |
| Direct expenses (GH¢ per unit) | 2 | 6 | 3 |
| Machine Department (machine hours per unit) | 2 hours | 5 hours | 4 hours |
Raw material costs GH¢4 per kilo, and the hourly rate for all labour is GH¢5. The direct expenses relate entirely to specialized packaging, which is uniquely designed for each of the products and is therefore directly attributable to that product alone.
The current costing system absorbs overheads to the Machine and Assembly Departments on the basis of a recovery rate of GH¢3.50 per machine hour and GH¢1 per labour hour respectively.
The following is an analysis of the overheads by department:
| Department | Overheads (GH¢) |
|---|---|
| Purchasing Department | 22,400 |
| Production Set-up & Design Dept | 34,500 |
| Customer Service Department | 32,600 |
| Machine Department | 123,000 |
| Assembly Department | 26,500 |
The Departmental Managers have provided the following additional information about operations in their departments:
| Activity | Taya | Maya | Paya | Total |
|---|---|---|---|---|
| Number of set-ups | 10 | 10 | 30 | 50 |
| Number of customer orders | 80 | 86 | 160 | 326 |
| Number of purchase orders | 30 | 32 | 50 | 112 |
The Machine Department is capital intensive, and the Assembly Department is labour intensive.
Required:
a) Calculate the prime cost for each product.
b) Calculate the profit per unit for each product if overheads are absorbed on the Current Costing basis.
c) Calculate the profit per unit for each product if overheads are absorbed using an Activity Based Costing approach. Clearly identify any cost drivers you assign.
d) Comment on why there is a difference between the profit/loss shown on an Absorption Costing basis and that shown using Activity Based Costing.
e) Identify THREE limitations of Activity Based Costing.
Answer
a) Prime cost for each product:
| Taya | Maya | Paya | |
|---|---|---|---|
| Direct materials @ GH¢4 per kg | 6 | 24 | 28 |
| Direct labour @ GH¢5 per hour | |||
| – Machine Dept | 5 | 40 | 30 |
| – Assembly Dept | 20 | 15 | 5 |
| Direct expenses | 2 | 6 | 3 |
| Prime cost | 33 | 85 | 66 |
(3 marks)
b) Profit per unit calculation using current absorption basis:
| Taya | Maya | Paya | |
|---|---|---|---|
| Prime Cost | 33.00 | 85.00 | 66.00 |
| Overhead absorption: | |||
| – Machine Dept @ GH¢3.50 per machine hour | 7.00 | 17.50 | 14.00 |
| – Assembly Dept @ GH¢1.00 per labour hour | 4.00 | 3.00 | 1.00 |
| Total Product Cost | 44.00 | 105.50 | 81.00 |
| Selling Price | 56.00 | 106.00 | 84.00 |
| Profit Per Unit | 12.00 | 0.50 | 3.00 |
(5 marks)
c) Per unit profit calculation using Activity Based Costing basis:
| Taya | Maya | Paya | |
|---|---|---|---|
| Overhead Allocation: | |||
| – Purchasing Dept (W1) | 6,000 | 6,400 | 10,000 |
| – Production Set-up & Dept (W2) | 6,900 | 6,900 | 20,700 |
| – Customer Service Dept (W3) | 8,600 | 8,600 | 16,000 |
| – Machine Dept (W4) | 35,000 | 40,000 | 48,000 |
| – Assembly Dept (W5) | 17,500 | 6,000 | 3,000 |
| Total Product overheads | 73,400 | 67,900 | 97,700 |
| Units Produced | 8,750 | 4,000 | 6,000 |
| Overhead per Unit | 8.39 | 16.98 | 16.28 |
| Prime Cost | 33.00 | 85.00 | 66.00 |
| Total Product Cost | 41.39 | 101.98 | 82.28 |
| Selling Price | 56.00 | 106.00 | 84.00 |
| Profit per Unit | 14.61 | 4.02 | 1.72 |
WORKINGS
Cost Drivers and Rates per unit of Cost Driver:
- W1: ABC cost per unit of driver for purchasing department:
GH¢ 22,400 / 112 = GH¢ 200 per purchase department - W2: ABC cost per unit of driver for set up & design department:
GH¢ 34,500 / 50 = GH¢ 690 per set up - W3: ABC cost per unit of driver for customer service department:
GH¢ 32,600 / 326 = GH¢ 100 per customer order - W4: ABC cost per unit of driver for machine department:
GH¢ 123,000 / 61,500 = GH¢ 2 per machine hour - W5: ABC cost per unit of driver for Assembly Department:
GH¢ 26,500 / 53,000 = GH¢ 0.50 per assembly labour hour - Machine Hours (Machine Dept):
Taya (8,750 x 2 hrs) = 17,500 hours
Maya (4,000 x 5 hrs) = 20,000 hours
Paya (6,000 x 4 hrs) = 24,000 hours
Total: 61,500 hours - Labour Hours (Assembly Dept):
Taya (8,750 x 4 hrs) = 35,000 hours
Maya (4,000 x 3 hrs) = 12,000 hours
Paya (6,000 x 1 hr) = 6,000 hours
Total: 53,000 hours
(11 marks evenly spread)
d) Comment on the difference between Absorption Costing and Activity Based Costing:
- Under the traditional absorption costing system, overheads are absorbed based on volume-driven cost drivers such as machine hours and labour hours. However, Activity-Based Costing (ABC) allocates overheads using more specific cost drivers, such as the number of setups, customer orders, and purchase orders. This results in more accurate product costing under ABC.
- In this case, Maya shows a higher profit under ABC due to its lower demand on overhead activities compared to its production volume. Paya, on the other hand, receives a higher allocation of overheads under ABC, leading to a lower profit per unit.
(3 marks)
e) Limitations of Activity Based Costing:
- High Implementation Costs: Implementing ABC systems is resource-intensive, requiring significant time and financial investments.
- Complexity: The complexity
- Tags: ABC Limitations, Cost Drivers, Overhead Allocation, Prime Cost, Profit Analysis
- Level: Level 2
- Topic: Activity-based costing
- Series: NOV 2017
- Uploader: Dotse