Managerial Accounting
Managerial Accounting
Managerial Accounting
Deeside plc manufactures three products, A, B and C in their factory and uses a factory-wide absorption rate for absorbing overheads based on direct labour hours. The following information relates to Period 5 of Year 3. Product Production (units) Direct Material Cost p.u. Direct Labour Hours p.u. A 12,000 40 4 B 8,000 30 6 C 4,000 20 2
Direct labour is paid at 8 per hour. The overhead costs for Period 5 are as follows: 312,000 56,000 80,000 128,000 100,000 676,000
(a) (b)
Calculate the factory-wide absorption rate for Period 5. Calculate the cost p.u. of each product under the traditional approach to treatment of overheads.
The company is considering using ABC as a method of arriving at the cost per unit of their products and the following information is available for this purpose: The overheads have been investigated and while machining costs will be absorbed on the basis of machine hours, cost drivers have been identified f or the other overheads. Overhead Set-up Assembling Goods Receiving Dispatch Cost Driver No. of production runs No. of production orders No. of receipts No. of production orders
The following additional information is also available: Product Machine hours per unit No. of Production runs No. of Material receipts No. of Production orders (c) (d) A 2 1 3 3 B 3 2 5 2 C 1 5 24 5
Calculate a cost driver absorption rate for each of the above overheads. Calculate the cost per unit for each product under the ABC system.
This question contains a lot of information and lots of figures and therefore it is important to read it carefully with a view to deciding which information relates to each part of the question. The purpose of this question is to show how t he traditional method of overhead absorption works and then to demonstrate the Activity -Based Costing approach. At the end of the question we will compare the two methods and see if we can explain the differing results they produce.
Solution
(a) This opening part of the question asks us to calculate a factory -wide overhead absorption rate (sometimes called a blanket rate), based on labour hours.
You should recall that the calculation of an overhead absorption rate divides the relevant overhead (which may be for a cost centre or, as in this case, for the whole factory) by the relevant units of the base selected. (There were actually six possibilities, i.e. per unit, % on material, % on wages, % on prime cost, per labour hour or per machine hour). In this question we are using labour hours and therefore the calculation is as follows: Overhead Absorption Rate =
Although we know the total factory overheads we need to calculate the total labour hours, i.e. A B C = 48,000 = 48,000 = 8,000 104,000
(b)
In this next part we are asked to calculate the total cost per unit for each product using the traditional approach.
This total cost will be the sum of the two direct costs material and labour, plus overheads. The question gives us the material cost p.u. for each product, but we will have to calculate the figures for labour and overheads . For labour this will be the number of labour hours per unit multiplied by the labour rate per hour. For overheads it will be the number of labour hours per unit multiplied by the overhead absorption rate calculated in part (a), i.e. Cost per unit Material Labour Overheads 98 117 49 A 40 32 (4 26 B 30 48 39 C 20 16 13
The remaining parts of the question now introduce the Activity -Based Costing technique. (c) This part asks us to calculate cost driver absorption rates for the separate overheads.
The total overhead of the factory has been broken down into five activities. For the first of these, machining, a traditional -style absorption rate is to be used, i.e. machine hour rate. Machine Hour Rate =
Once again we know the overhead but need to calculate the machine hours, i.e. A B C = 24,000 = 24,000 = 4,000 52,000
For the other activities, which comprise the factory overheads, appropriate cost drivers have been identified and we can use these to calculate the relevant absorption rate. The cost drivers identified are the number of production runs, the number of production orders and the number of receipts. Therefore before we go any further we must calculate the relevant figure for each driver. Production Runs A B C 1 2 5 8 3 2 5 10 3 5 24 32
Production Orders
A B C
Receipts
A B C
Now we can calculate the absorption rate for each activity, based on the relevant cost driver.
Set-up
56,000 8
80,000 10 128,000 32
Assembling
Goods Receiving
Dispatch
100,000 10
(d)
The final part requires us to use these figures to produce a cost per unit for each product. Therefore we need to calculate the overhead cost per unit to add to the material and labour costs which we calculated in part (b).
Machinery overhead is the simplest, i.e. machine hours per unit multiplied by machine hour rate. A B C 6 = 18
For the other overhead activities we need to relate the cost driver absorption rate to the units produced.
A 7,000 12,000 = 0.58 B 14,000 (7,000 8,000 = 1.75 16,000 8,000 = 2 20,000 8,000 = 2.50 20,000 8,000 = 2.50 C 35,000 4,000 = 8.75 40,000 4,000 =10 96,000 4,000 = 24 4,000 = 12.50 50,000
Set-up
Assembling 24,000 (8,000 12,000 =2 Goods Receiving 12,000 12,000 =1 30,000 12,000 = 2.50
Dispatch
Therefore using ABC total cost per unit for the products would be as follows: A B C 40 30 20 32 48 16 12 18 6 0.58 1.75 8.75 2 2 10 1 2.50 24 2.50 2.50 12.50 90.08 104.75 97.25 Contrast these figures with the ones produced in the answer to part (b) of the question. The most striking change is in the increase in the cost per unit of Direct Materials Direct Labour Machinery Set-up Assembling Goods Receiving Dispatch
Product C, although there is also a less substantial decrease in the cost per unit of the other two products. The increase in the cost of C has arisen because most of the charges relating to C were not identified under the traditional absorption system. The cost drivers identified in the ABC system are responsible for generating these charges and thu s we can suggest that the ABC system produces a more accurate cost for each product. The following examples will provide practice in applying the ABC system. Solutions are provided at the end of this section.
Question 1
Your company currently produces and sells 4 products, Alpha, Beta, Gamma and Delta. The following information relates to Period 3. Alpha 180 46 21 4 6 30 18 Beta 150 58 14 3 5 30 15 Gamma 120 35 7 2 4 30 12 Delta 180 70 14 3 6 30 18
Production (units) Costs per unit: Direct material Direct labour Machine hours per unit Number of production runs Number of requisitions raised Number of orders completed
Currently the production overhead is absorbed by the machine -hour rate method and the following are the total production ove rhead costs for Period 3. 24,540 6,300 7,200 3,150 7,560 48,750
Machine Department Set-up costs Receiving costs Inspection costs Despatch costs
Cost drivers have been identified as follows: Set-up costs Stores receiving Inspection Despatch Number Number Number Number of of of of production runs requisitions raised production runs orders completed
You are required to calculate: (a) (i) The machine-hour rate currently used to absorb the production overhead. The total cost per unit for each product if overheads are absorbed by the method in (a)(i).
(ii)
(b)
The cost per unit for each product using an ABC approach.
Question 2
Jomit plc has budgeted for the following overhead costs for Period 6. 31,200 39,000 27,300
The company produces 3 products, P, Q and R for which the following budgeted information is available for Period 6. Product Output (units) Material batches Per Unit Direct material (kg) Direct material () Direct labour (hours) Number of power operations Direct labour rate per hour P 4,000 20 Q 3,000 10 R 1,600 32
4 6 0.2 6 8
6 5 0.5 3 8
3 9 1.0 2 8
Currently the overhead costs are each absorbed using a rate per direct labour hour. However, the company is considering applying overheads using an ABC approach and has identified drivers for the activities as follows: Material receipt costs Power costs Material handling costs You are required to calculate: (a) The total cost per unit for each product using the current overhead absorption method. The total cost per unit for each product using the ABC method. number of batches of material number of power operations kg of material handled
(b)
Question 3
Your company currently produces a range of three products, D, E and F to which the following details relate for Period 2. D 1,500 18 1 3 E 2,500 10 3 2 F 14,000 20 2 6
Production (units) Material cost per unit Labour hours per unit Machine hours per unit
Labour costs are 8 per hour and production overheads are currently absorbed in the conventional system by reference to machine hours. Total production overheads for Period 2 have been analysed as follows: 327,250 187,000 140,250 280,500 935,000
(a)
Calculate the cost per unit for each product using conventional methods.
The introduction of an ABC is being considered and to that end the following volume of activities have been identified with the current output levels. D 90 16 180 E 138 28 216 F 576 116 804
Calculate the cost per unit for each product using the ABC approach.
Question 4
The following table summarises the details of the production le vels, costs and cost drivers for Abtronics Ltd who have traditionally absorbed overheads into production on the basis of a labour hour absorption rate. They wish to move to an ABC system. Product Material cost per unit Labour hours per unit Machine hours per unit Number of production runs Number of production orders Number of orders delivered Number of receipts Production (units) P 20 4 4 6 45 30 12 15,000 Q 15 6 3 14 30 20 28 10,000 R 10 3 6 40 75 50 80 4,000
Labour hours are paid for at 10 per hour. Overheads Machining Set-up costs Receiving costs Packing costs Engineering costs 684,000 60,000 240,000 300,000 450,000 1,834,000 Cost Driver machine hours production runs number of receipts number of orders delivered number of production orders
(a)
Calculate the cost per unit for each product using the traditional overhead absorption approach. Calculate the cost per unit using the ABC approach.
(b)
Question 5
Param plc has incurred the following overheads in its factory during Period 6. 90,000 135,000 105,000 120,000 150,000
Param plc produces a range of products, two of which are Product X and Product Y. The following information relate to these two products. X 5 8 150 500 1,000 3 10,000 Y 8 12 210 300 800 2 6,000
Material costs per unit Labour cost per unit Number of process set-ups Number of purchase orders issued Number of customer orders Machine hours per unit Production (units)
Inspection takes place after each process set-up. The cost drivers which have been identified for the factory are: Quality control Process set-ups Purchasing Order processing Occupancy costs 450 inspections 450 set-ups 1,000 purchase orders 2,000 customer orders 75,000 machine hours
Calculate the cost per unit for Products X and Y using: (i) (ii) existing overhead absorption rate per machine hour an activity-based costing approach.
Solutions
Question 1 (a) (i) Total machine hours: Alpha Beta Gamma Delta 720 450 240 540 = 1950
48,750 1,950 = 25
(ii)
Alpha 46 21 100 167 Driver m/c hours Runs Requisitions Runs Orders
Beta 58 14 75 147
Gamma 35 7 50 92
(b)
1800 = 10 180
1500 = 10 150
1200 = 10 120
1800 = 10 180
Receiving
1800 = 10 180
1800 = 12 150
1800 = 15 120
1800 = 10 180
Inspection
900 = 5 180
750 = 5 150
600 = 5 120
900 = 5 180
Despatch
2160 = 12 180
1800 = 12 150
1440 = 12 120
2160 = 12 180
Machine Dept
= 50.32
= 37.74
= 25.16
= 37.74
Total cost per unit Materials Labour Set-up Receiving Inspection Despatch Machine Dept
Power
Material handling
P = 1.60 = 2
Q = 4 = 5 = 3.50
R = 8 10 = 10 = 7
Power
Material handling
= 1.40
Total cost per unit Direct material Direct labour Material receipt costs Power costs Material handling
(b)
Power
Material handling
P
503.23 20 4,000
Q
503.23 10 3,000
R
503.23 10 1,600
= 2.52 Power = 6.48 = 2.80 P 6.00 1.60 2.52 6.48 2.80 19.40
= 1.68 1.08 = 3.24 = 4.20 Q 5.00 4.00 1.68 3.24 4.20 18.12
= 10.06 1.08 = 2.16 = 2.10 R 9.00 8.00 10.06 2.16 2.10 31.32
Material handling
Total cost per unit Direct material Direct labour Material receipt costs Power costs Material handling costs
Question 3 (a) Number of machine hours = D = E = F 2,500 = = = = 4,500 5,000 84,000 93,500
935,000 93,500
= 10 per machine hour Cost per unit Material Labour Overhead D 18 8 30 56 E 10 24 20 54 = 90 + 138 + 576 = 804 F 20 16 60 96
(b)
Issue
16 1,168.75 28 1,168.75 116 1,168.75 1,500 2,500 14,000 = 12.47 = 13.09 = 9.68
Machining
1.50 = 4.50
180 233.75 1,500 = 28.05
= 3
216 233.75 2,500 = 20.20
= 9
804 233.75 1,400 = 13.42
Inspection
Total cost per unit Material Labour Set-up costs Handling costs Machine costs Inspection costs
(b)
Set-up costs
60,000 (6 + 14 + 40)
= 1,000 per production run
Receiving costs
Packing costs
Engineering costs
P 6.00 = 24.00
6 1,000 15,000 = 0.40
12 2,000 15,000 = 1.60 30 3,000 15,000 = 6 45 3,000 15,000 = 9
Q = 18.00
14 1,000 10,000 = 1.40
28 2,000 10,000 = 5.60 20 3,000 10,000 = 6 30 3,000 10,000 = 9
R = 36.00
40 1,000 4,000 = 10
80 2,000 4,000 = 40 50 3,000 4,000 = 37.50 75 3,000 4,000 = 56.25
Set-up costs
Receiving costs
Packing costs
Engineering costs
Total cost per unit Direct material Direct labour Machining Set-up Receiving Packing Engineering
Question 5 (i) Total Factory Overheads = 90,000 135,000 105,000 120,000 150,000 600,000
= 75,000
600,000 75,000 = 8 per machine hour
(ii)
90,000 450
Process set-up
135,000 450
105,000 1,000 120,000 2,000
150,000 75,000
Purchasing
Order processing
= 60 per order
Occupancy costs
X
150 200 10,000 = 3
150 300 10,000 = 4.50 500 105 10,000 = 5.25 1,000 60 10,000 = 6
Y
210 200 6,000 =7
210 300 6,000 = 10.50 300 105 6,000 = 5.25 800 60 6,000 = 8
Process set-up
Purchasing
Order processing
Occupancy
Cost per unit Material Labour Quality control Set-up Purchasing Order processing Occupancy