- 25 Marks
MA – Nov 2017 – L2 – Q3 – Activity-based costing
Calculate the prime cost, profit per unit using both absorption and activity-based costing, and comment on the differences and limitations.
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.
Find Related Questions by Tags, levels, etc.
- Tags: ABC Limitations, Cost Drivers, Overhead Allocation, Prime Cost, Profit Analysis
- Level: Level 2
- Topic: Activity-based costing
- Series: NOV 2017