SOLUTION: Q.36 – RODEO ABC CO. LTD.

a. Traditional Overhead Absorption:-

€840,000
O.H.A.R. = = €6 per direct labour hour

140,000

A B C
Direct materials 3 2 1
Direct labour 6 8 4
Production overhead 9 12 6
18 22 11

b. Activity Based Costing:

Set-up costs 120,000 = €4,000 per set-up

30

Machine costs 580,000 = €2. per machine hour

290,000

A B C
Direct materials 3.00 2.00 1.00
Direct labour 6.00 8.00 4.00
Set-up costs 0.40 1.33 12.00
Machining costs 8.00 4.00 12.00
Packaging 0.56 1.86 11.20
17.96 17.19 40.20
 SOLUTION: Q.37 – LAVERNE SUPPLIES LTD.

a. Direct labour hours

A 3,000 x ½ = 1,500
B 2,000 x 1 = 2,000
C 1,500 x 1/3 = 500
4,000

Absorption rate for overhead = €165,000/4,000

= €41.25 per direct labour hour

Unit cost of C = €(8 + 2 + 1/3 of 41.25) = €23.75

b. Overhead Rates

Machining €71,500/11,000 machine hours = €6.50 per machine hour

Set-up costs €10,500/20 production runs = €525 per run
Materials handling €35,000/40 materials deliveries = €875 per delivery
Packing costs €22,500/15 deliveries to customers = €1,500 per delivery
Engineering €25,500/50 production orders = €510 per order

Product C Overhead Costs

€
Machinery (3,000 machine hours x €6.50) 19,500
Set-up costs 10 production runs x €525 5,250
Materials handling 20 deliveries x €875 17,500
Packing costs 10 customer deliveries x 15,000
€1,500
Engineering 15 production orders x €510 _7,650
64,900

Cost Per Unit of C

€
Direct materials 8.00
Direct labour 2.00
Overhead (€64,900/1,500 units of C) 43.27
53.47
 SOLUTION: Q. 38 - WONG LTD.
(a) Overhead absorbed on basis of direct labour hours
Factory overhead 95,000
Direct labour hours
BETA 50,000 units @ 0.375 hours 18,750
GAMMA 5,000 units @ 1 hour 5,000 23,750
Overhead rate per direct labour hour 95,000/23,750 €4

BETA GAMMA
Direct materials 2.00 2.80
Direct labour 1.50 4.00
Factory overhead
BETA 0.375 hours @ €4 1.50
GAMMA 1 hour @ €4 ____ 4.00
5.00 10.80
(b) ACTIVITY BASED COSTING
Indirect labour 30,000
Machine re-tooling 15,000 45,000
Production runs 150
Ind. labour & m/c re-tooling per run €300

Materials handling 27,000

Deliveries 60
Material handling per delivery €450

Electricity 23,000
Machine hours 11,500
Electricity per machine hour €2

BETA GAMMA
Indirect labour & m/c re-tooling
Beta 50 @ €300 15,000
Gamma 100 @ €300 30,000

Materials handling
Beta 12 @ €450 5,400
Gamma 48 @ €450 21,600

Electricity
Beta 7,000 @ €2 14,000
Gamma 4,500 @ €2 ______ 9,000
34,400 60,600
Units 50,000 5,000
Overhead per unit €0.69 €12.12
Activity based costing
BETA GAMMA
Direct materials 2.00 2.80
Direct labour 1.50 4.00
Factory overhead 0.69 12.12
4.19 18.92

Traditional costing
Direct materials 2.00 2.80
Direct labour 1.50 4.00
Factory overhead 1.50 4.00
5.00 10.80
 SOLUTION: Q.39 – ST. JOHN’S HOSPITAL.

a) Daily rate = €3,145,000/6,000 = €524.17 per day

This is the amount charged to each patient regardless of severity. This

approach is comparable to the unit-based cost assignment found in
traditional manufacturing environments.

b) Pool rates:

Accommodation and catering: €1,000,000/6,000 = €166.67 per patient

day.
Monitoring: €1,200,000/10,000 devices = €120 per device used.
Nursing Care: €945,000/63,000 = €15 per hour of care.

c) Daily rates:

Patient type:
High severity:
Pool 1: €166.67 x 2,000 = € 333,340
Pool 2: €120 x 5,000 = 600,000
Pool 3: €15 x 40,000 = 600,000
Total €1,533,340
Patient days 2,000
Daily rate € 766.67

Medium severity:
Pool 1: €166.67 x 3,000 = € 500,010
Pool 2: €120 x 4,000 = 480,000
Pool 3: €15 x 18,000 = 270,000
Total €1,250,010
Patient days 3,000
Daily rate € 416.67

Low severity:
Pool 1: €166.67 x 1,000 = € 166,670
Pool 2: €120 x 1,000 = 120,000
Pool 3: €15 x 5,000 = 75,000
Total € 361,670
Patient days 1,000
Daily rate € 361.67

d) The results for this problem clearly indicate that ABC can be useful for service
industries. Service organisations have multiple products, and product diversity
is certainly possible. Furthermore, many service industries are facing increasing
competition just like the manufacturing sector, and accurate cost information is
needed (e.g., consider hospitals and airlines and the problems they are having).
SOLUTION: Q.40 – SELKS PRODUCTS plc.

(a) Per unit profit calculation using traditional basis:

X Y Z
€ € €
Prime costs 33.00 85.00 66.00
Machining dept. 7.00 17.50 14.00
Assembly dept. 7.00 3.00 2.00
Total cost 47.00 105.50 82.00
Selling price 56.00 106.00 84.00
Profit 9.00 0.50 2.00

(b) Workings.

W l.
ABC cost per unit of the driver for Machining Dept.:

€84,000/42,000 = €2 per machine hour.

W 2.
ABC cost per unit driver for Assembly Dept.:

€26,500/53,000 = €0.50 per assembly labour hour

W 3.
ABC cost per unit driver for Set up cost pool

€34,500/50 = €690 per set up

W 4.
ABC cost per unit driver for Customer order processing

€32,600/326 = €100 per customer order

W 5.
ABC cost driver per unit driver for Purchase order processing

€22,400/112 = €200 per purchase order.

(b) Cont’d.

The per unit level of ABC cost is as follows:

X Y Z
€ € €
Prime costs 33.00 85.00 66.00
Machining dept. 4.00 10.00 8.00
Assembly dept. 3.50 1.50 1.00
Set-up 1.38 3.45 4.60
Sales order processing 1.60 2.15 5.33
Purchase order processing 1.20 2.00 2.80
44.68 104.10 87.73

Per unit profit per unit using ABC.

X Y Z
€ € €

Cost per unit 44.68 104.10 87.73

Selling price 56.00 106.00 84.00
Profit/loss per unit €11.32 €1.90 €(3.73)

(c ) Product Z

Profit per unit using traditional costing: €2.00

Loss per unit using ABC (€3.73)

The difference in unit profit/loss between the two costing approaches is due to the different
approaches in applying overhead. Under the traditional approach, the overhead is absorbed
using only volume-based cost drivers (machine hours and assembly hours). Using ABC three
of the cost pools have cost drivers driven by the number of transactions. While product Z is
the lowest volume product it makes greater demands on set-up costs, customer order and
purchase order processing than the other two products. As can be seen from the workings in
part (b), Product Z has the highest per unit ABC cost for the three cost pools mentioned
above at €4,60, €5.33 and €2.80 compared to the higher volume products X and Y. Under
traditional costing Product Z will get an understated amount of these costs as the cost drivers
are purely volume based.
Solution Q41
(A) Calculation of normal level of activity - based on annual production levels
Playhouses - 6,000 units @ 6 hours (€60/€10 per hour) per unit 36,000
Jungle gyms - 4,000 units @ 8 hours (€80/€10 per hour) per unit 32,000
Total direct labour hours = 68,000
Predetermined overhead absorption rate = €1,360,000/68,000 = €20 per direct labour hour
Calculation of absorption cost per unit based on approach currently employed
Playhouses Jungle Gyms
€ €
Direct material 125 145
Direct labour 60 80
Production overheads
(€20 * 6) 120 (€20 * 8) 160
absorbed
Absorption cost per unit 305 385

(B) Workings
Calculation of cost driver rates
Purchasing €240,000/800 requisitions = €300 per requisition
Setting-up €360,000/450 set-ups = €800 per set-up
Machining €480,000/8,000 machine hours = €60 per machine hour
Quality control €280,000/350 inspections = €800 per inspection

Calculation of overhead absorption rate per unit using ABC

Playhouses Jungle Gyms
Purchasing 600 €300 €180,000 200 €300 €60,000
Setting-up 310 €800 €248,000 140 €800 €112,000
Machining 4,200 €60 €252,000 3,800 €60 €228,000
Quality
200 €800 €160,000 150 €800 €120,000
control
€840,000 €520,000
No of units 6,000 4,000
Overhead absorption rate per unit under
€140 €130
ABC

Direct material 125 145

Direct labour 60 80
€325 €355

(C) Discuss why the costs are higher or lower for each product using the traditional
system in part (A) compared to the ABC system in part (B).

None of the company's production overheads appear to be driven by direct labour hours,
although this is the basis adopted for the volume based approach currently adopted.
Differences between the absorption costs per unit calculated under the approach currently
employed by Moose Ltd and those calculated using ABC suggest that the company is
currently under-costing Playhouses and over-costing Jungle gyms and reflect differences in
the patterns of overhead consumption by the two products.
(D) Discuss the appropriateness of introducing ABC to Moose Ltd given the company’s
particular circumstances.

The information generated by ABC is most likely to benefit an organisation in which:

 production overheads are significant relative to direct costs
 factors other than production volume drive production overhead resource
consumption;
 a variety of products are produced and the consumption of overhead resources varies
across the production range.

The €1,360,000 incurred on fixed production overheads amounts to over 50% of Moose Ltd's
total production costs of €2,538,000 ([€305*6,000] + [€385*4,000]). Therefore the level of
expenditure on production overheads in this company is significant and the approach adopted
for overhead absorption will have a considerable impact on the determination of product
costs within this organisation. As this company employs a cost-plus approach to determining
selling prices for their products, distortions in product costing will also impact on selling
prices charged and may impact on competitiveness. As discussed above this currently appears
to be the case.
It would appear that the disappointing sales performance for Jungle gyms may be due to the
over-costing of this product resulting in the selling price being too high. Conversely, the high
market demand for Playhouses is likely to reflect that, due to an understatement of the costs
incurred in its production, its selling price is lower than that charged by competitors.