Seminar 5 – Activity-Based Costing

Question 1. Product costs

Parker Company produces mathematical and financial calculators. Data related to the two products
are presented here.
  Mathematical Financial
Annual production in units 50,000 100,000
Direct material costs $150,000 $300,000
Direct manufacturing labor costs $50,000 $100,000
Direct manufacturing labor-hours 2,500 5,000
Machine-hours 25,000 50,000
Number of production runs 50 50
Inspection hours 1,000 500

Total manufacturing overhead costs are:

Total
Machining costs $375,000
Setup costs $120,000
Inspection costs $105,000
The Company currently allocates production overheads to products on the basis of direct labor hours.
Required:
1. Compute the product costs using the current traditional costing system.
2. Compute the product costs using an activity-based costing system.
3. Compare results and comment on the differences.

Question 2. Comparison of traditional and ABC costing

First Class Corporation currently produces three types of products, A, B, and C. The following
information is available:
Product A Product B Product C Total
(a) Production and sales (units) 30,000 20,000 8,000
(b) Raw material usage (number of components) 5 5 11
(c) Direct material cost / unit $25 $20 $11 $1,238,000
(d) Direct labor hours / unit 1⅓ 2 1 88,000
(e) Machine hours / unit 1⅓ 1 2 76,000
(f) Direct labor cost / unit $8 $12 $6
(g) Number of production runs 3 7 20 30
(h) Number of deliveries 9 3 20 32
(i) Number of receipts (b x g)* 15 35 220 270
(j) Number of production orders 15 10 25 50
* The company operates a just-in-time inventory policy, and receives each component once per
production run.

(k) Overhead costs: Production order - A form issued to the production

Set-up $30,000 department of an organization specifying the production to
Machines $760,000 be carried out by the department. A production order gives,
Receiving $435,000 inter alia, a description of the operations to be carried out,
Packing $250,000 the quantities to be produced, the time allowed, and the
Engineering $373,000 completion times.
$1,848,0
00
The corporation currently allocates production overheads to products on the basis of direct labor
hours.
Required:
1. Compute the product costs using the current traditional costing system.
2. Compute the product costs using an activity-based costing system.

Question 3. Comparison of traditional and ABC costing

1. The following information provides details of the cost, volume and cost drivers for products A and
B in ABC Ltd.
A B
Products and sales (units) 60 000 20 000
Direct Material cost (per unit) $ 20 $ 10
Direct labor hours (per unit) 2 1
Direct Labor cost (per unit) $8 $4
Number of production runs 3 7
Number of purchase order 2 5
Number of customer orders 3 6
Number of product notice 4 7

Product overhead cost:

Set-up 40 000
Purchasing 28 000
Sales order 17 000
processing
Engineering 10 000
Total: $95 000

Required:
a) Calculate the unit product costs using traditional costing system. Use direct labor hours to
allocate overhead costs.
b) Calculate the unit product costs using an activity-based costing (ABC) system
c) Comment on the results. What is broad averaging and what consequences can it have on
costs? Why should managers worry about overcosting and undercosting?
d) Comment on strong and weak points of ABC.

Question 4. ABC costing

Company X manufactures a variety of hand-crafted bed frames. The company’s manufacturing
activities and related data for the current year follow:
Activity Estimated cost, Cost driver used as Estimated volume
$ allocation base for cost driver
Material handling 400,000 Number of parts 800,000 parts
Cutting 1,200,000 Machine hours 40,000 hours
Assembly 3,000,000 Direct labor hours 150,000 hours
Wood staining 1,320,000 Number of frames stained 60,000 frames
Two styles of bed frames were produced in July, a wood frame with fewer parts and a metal frame
that required no staining activities. Direct labor is paid $25 per hour. Their quantities, direct material
costs and other data follow:
Units Direct Machine Number of Direct labor
produced material hours parts hours
Wood frames 5,000 $600,000 5,000 100,000 6,000
Metal frames 1,000 $200,000 500 10,000 3,000
Required:
Compute the ABC cost allocation rates and then calculate total manufacturing costs and unit costs of
the wood and metal frames.
Question 5. (Hometask) Activity-Based Costing as an Alternative to Traditional Product
Costing
Erte, Inc., manufactures two models of high-pressure steam valves, the XR7 model and the ZD5
model. Data regarding the two products follow:

Total Direct Labor-

Product Direct Labor-Hours Annual Production
Hours
XR7 . . . . . . . . . . 0.2 DLHs per unit 20,000 units 4,000 DLHs
ZD5 . . . . . . . . . . 0.4 DLHs per unit 40,000 units 16,000 DLHs
20,000 DLHs

Additional information about the company follows:

a. Product XR7 requires $35 in direct materials per unit, and product ZD5 requires $25.
b. The direct labor rate is $20 per hour.
c. The company has always used direct labor-hours as the base for applying manufacturing overhead
cost to products. Manufacturing overhead totals $1,480,000 per year.
d. Product XR7 is more complex to manufacture than product ZD5 and requires the use of a special
milling machine.
e. Because of the special work required in (d) above, the company is considering the use of activity
based costing to apply overhead cost to products. Three activity cost pools have been identified and
the first-stage allocations have been completed. Data concerning these activity cost pools appear
below:
Estimated Total Estimated Total Activity
Activity Cost Pool Activity Measure
Cost XR7 ZD5 Total
Machine setups . . . . . . . Number of setups $ 180,000 150 100 250
Special milling . . . . . . . Machine-hours 300,000 1,000 0 1,000
General factory . . . . . . Direct labor-hours 1,000,000 4,000 16,000 20,000
$1,480,000

Required:
1. Assume that the company continues to use direct labor-hours as the base for applying overhead
cost to products.
a. Compute the predetermined overhead rate.
b. Determine the unit product cost of each product.
2. Assume that the company decides to use activity-based costing to apply overhead cost to products.
a. Compute the activity rate for each activity cost pool. Also compute the amount of overhead
cost that would be applied to each product.
b. Determine the unit product cost of each product.
3. Explain why overhead cost shifted from the high-volume product to the low-volume product under
activity-based costing.