PERFOMANCE MANAGEMENT (B5) COVENANT FINANCIAL CONSULTANTS LIMITED

Review Questions on Activity Based Costing (ABC)

Question 1 (NBAA Adapted)

(a) Having attended a CPE programme conducted by the NBAA on Activity Based Costing
(ABC) you decided to experiment by applying the principle of ABC to the four products
currently being produced and sold by your company. 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
Cost per unit Shs‘000’ Shs’000’ Shs’000’ Shs’000’
Direct materials 40 50 30 60
Direct labour 28 21 14 21
Machine hour (per unit 04 03 02 03

The four products are similar and are usually produced in production runs of 20 units and sold
in batches of 10 units.

The production overheads are currently absorbed by using a machine hour rate and the total of
the production overhead for the period has been analyzed as follows:

Shs
Machine department costs (rent, business rate, department and 10,430,000
supervision
Set costs 5,250,000
Stores receiving 3,600,000
Inspection/quantity control 2,100,000
Material handling and dispatch 4,620,000

You have ascertained that the ‘cost drivers to be used are as listen below for the overhead costs
shown:
Overhead Cost Cost Driver
Set up costs Number of production run
Store receiving requisitions raised
Inspections/quality control Number of production runs
Material 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:
(a) Calculate the cost for each product if all overhead costs are absorbed on a machine hour
basis. (4 marks)
(b) Calculate the total cost for each product, using activity-based costing (15 marks)

Prepared By: Godson Mkaro (Jr): MSc Finance & Investment, BSc. Computer Science, ATEC II, CPBE, CPA (T),
& Goodhope Mkaro (Sr): MBA(Finance), BCOM Acc(Hons), PGD in Tax Management, CPB, CISI(UK), CPA (T)
Phone: +255 717 / 769 348 616 | Email: info@covenantfinco.com |Website: www.covenantfinco.com Page | 1
 PERFOMANCE MANAGEMENT (B5) COVENANT FINANCIAL CONSULTANTS LIMITED

(c) Calculate and list the unit product costs from your figures in (a) and (b) above, to show
the difference and to comment briefly on any conclusion which may be drawn that/and
which could have pricing and profit implications. (4 marks)
(d) (i) what do you understand by the term” through put accounting”.
(ii) Contribution in its traditional form (Sale – Variable costs because capacity factors
and the rate of production are ignored

REQUIRED:
How are product returns and product cost measured under throughput accounting (TA)?
(4 marks) (Total: 23 marks)
Question 2 (ACCA Adapted)
The following information provides details of the volume and cost drivers for a particular period
in respect of ABC Company Limited.
Product X Product Y Product Z Total
Production/sales in units 30,000 20,000 8,000
Raw materials usage in units 5 5 11
Direct materials cost in Tsh per unit 25 20 11 1,238,000
1
Direct labor hours per unit 1 2 1 88,000
3
Direct labor cost in Tsh per hour 8 12 6
No of production run 3 7 20 30
1
Machine hours 1 1 2 76,000
3
No of orders deliveries 9 3 20 32
No of receipts (order received) 15 35 220 270
No of production order 15 10 25 50
Total overhead cost is allocated in the following cost objects
Set up cost 30,000
Machines cost 760,000
Receiving Cost 435,000
Packing cost 250,000
Engineering cost 373,000
Total 1,848,000

In the past the company has allocated overheads to products on the basis of direct labour hours.
However, the majority of overheads are closely related to machine hours than direct labour hours.

The company has recently redesigned it cost system by recovering overheads using two volume
related bases, machine hours and materials handling overheads rate for recovering overheads of
receiving department. Both the current and the previous cost system reported low profit margins
for product X, which is the company’s highest selling product. The management accountant has
recently attended the conference on activity-based costing, and overheads cost for the period has
been analyzed by the major activities in order to compute activity–based costs.

From the above information you are required to :-

(a) Compute the product cost using a traditional volume related costing system based on the
assumption that:

Prepared By: Godson Mkaro (Jr): MSc Finance & Investment, BSc. Computer Science, ATEC II, CPBE, CPA (T),
& Goodhope Mkaro (Sr): MBA(Finance), BCOM Acc(Hons), PGD in Tax Management, CPB, CISI(UK), CPA (T)
Phone: +255 717 / 769 348 616 | Email: info@covenantfinco.com |Website: www.covenantfinco.com Page | 2
 PERFOMANCE MANAGEMENT (B5) COVENANT FINANCIAL CONSULTANTS LIMITED

(i) All overheads are recovered of direct labour ( i.e the company’s past product costing
system)
(ii) The overheads of the receiving department are recovered by materials handling overhead
rate as a percentage of the purchase price and the remaining overheads are recovered
using a machine hours rate (i.e. the company’s current costing system.
(b) Compute product cost using an activity based costing system
(c) Briefly explain the differences between the product cost computation in (a) and (b)

QUESTION 9: (NBAA Adapted)

Mtoni Kijichi Co. operates an activity based costing system and has forecast the following for the
next year.
Cost Pool Cost (Tshs) Cost driver Number of drivers
Production set ups 105,000,000 Set up 300
Production testing 300,000,000 Tests 1,500
Component supply 25,000,000 Component orders 500
and storage
Customers’ orders 112,500,000 Customers’ orders 1,000
and delivery

Generally fixed overheads such as lightning and heating, which can-not be linked to any specific
activity are expected to be Tshs 900,000,000 and these overheads are absorbed on the basis of
direct labour hours. Total direct labours hours for the next year are expected to be 300,000 hours.

Mtoni Kijichi Co. specializes in production WEYE and expects orders for product WEYE next
year to be 100 orders of 60 units per order and 60 orders of 50 units per orders. The company
holds no inventories of product WEYE and will need to produce the order requirements in the
production runs of 900 units. One order for components is placed prior to each production run.
Four tests are made during each production run to ensure that quality standards are maintained.

The following additional costs and profit information relates to product WEYE.
Component Tshs 1,000 per unit
Direct labour 10 minutes per unit at Tshs 7,800 per hour
Profit mark up 40% of total unit costs.

REQUIRED:
(a) Calculate the activity based recovery rates for each cost pool (4marks)
(b) Calculate the total unit cost and selling price of productive WEYE (8marks)
(c) Discuss the reasons why activity based costing may be preferred to traditional absorption
costing in the modern manufactured environment. (8 marks )

Prepared By: Godson Mkaro (Jr): MSc Finance & Investment, BSc. Computer Science, ATEC II, CPBE, CPA (T),
& Goodhope Mkaro (Sr): MBA(Finance), BCOM Acc(Hons), PGD in Tax Management, CPB, CISI(UK), CPA (T)
Phone: +255 717 / 769 348 616 | Email: info@covenantfinco.com |Website: www.covenantfinco.com Page | 3

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