EXRCISE & SOLUTION

CHAPTER 7
ACTIVITY BASED COSTING

1. Sazzy Books produces a range of notebooks and diaries that are sold exclusively online
via the company’s website. Customers have the opportunity to personalize their
purchase by selecting designs for the front and back covers of the notebooks or diaries.
The company currently uses a traditional overhead absorption costing system based on
machine hours to allocate manufacturing overheads to products. This year, the company
recorded a loss in its financial statements for the first time since it commenced trading
six years ago. However, the management accountant has suggested that the problem
relates to overhead allocation. He has argued for the adoption of activity-based costing.
Activity based cost information obtained for the company shows that customers place
individual orders and then discuss the design of the notebooks or diaries using emails.
The artwork costs depend on the number of setups required to compile the notebook or
diary. In addition, the company has a policy of despatching each order individually.
Financial information relating to the most recent trading period and two orders recently
received are provided below.

Overhead costs Activity drivers

Ordering costs RM7,200 48,000 Total orders
received
Design expenses RM28,500 356,250 Total design
consultation
emails
Artwork RM17,250 115,000 Total artwork
setups
Despatch costs RM10,800 90,000 Total packets
despatched
21,250 Total machine
hours
 Details of two orders Notebook KJ34 Diary XT501
received
Direct materials – paper, RM1.86 RM1.24
binding, etc.
Direct labour RM0.52 RM0.68
Machine hours required 0.20 0.30
Number of design 3 5
consultations
Number of artwork setups 4 8
required

Required:
(a) Calculate the cost of each of the orders received using:
(i) The existing/traditional overhead allocation method.
(5 marks)
(ii) Activity based costing (ABC).
(15 marks)

SOLUTION
Workings:
Calculation of overhead rate:
Overhead rate per machine hour
Total production overheads = RM63,750/21,250=RM3.00
Notebook KJ34 Diary XT501
Direct materials 1.86 1.24
Direct labour 0.52 0.68
Production overhead (0.2 hr/0.3 hr x RM3.00 (W1)) 0.60 0.90
Total product cost 2.98 2.82
 overhead 63750
Total production =

21250

RM3
=

Notebook ↑ote book

k]34 -7501

DirectMaterials 1.86 1.24

Direct labor 0.52 0.68

productoverhead (0.210.37 x3 0.6 0.9

Total 2.98 2.82

product cost
(i) Activity based costing

Workings
(W2) Calculation of cost per driver

Overhead Activity drivers Activity

costs driver per
rate

Ordering costs RM7,200 48,000 Total orders RM7,200/

received 48,000
=RM0.15
Design RM28,500 356,250 Total design RM28,500/3
expenses consultation 56,250
emails =RM0.08
Artwork RM17,250 115,000 Total artwork RM17,250/
setups 115,000
=RM0.15
Despatch costs RM10,800 90,000 Total packets RM10,800/9
despatched 0,000
=RM0.12

Notebook KJ34 Diary XT501

ABC: RM RM
Number of usage
Ordering costs ↑ of
each
0.15 0.15
product
Design expenses (RM0.08 X 3, 5) 0.24 0.40
Artwork (RM0.15 X 4, 8) 0.60 1.20
Despatch costs 0.12 0.12
Total overhead costs 1.11 1.87
Product cost
:

Notebook KJ34 Diary XT501

Direct materials RM1.86 RM1.24
Direct labour RM0.52 RM0.68
Overhead costs RM1.11 RM1.87
Total product cost RM3.49 RM3.79