ACC200 Assignment on Overhead Costing and Activity Based Costing

This assignment discusses the issue of inaccurate allocation of overhead costing faced by many business organizations holding manufacturing facilities. It advocates the use of activity based costing and dynamic overhead rate as the most suitable method of resolving the issue. It also includes advice on accounting standards and causes of over and under allocation of overhead cost.

ACC200 Term 2 2018 Assignment

Executive Summary:
The assignment is a good representation of the common issue of inaccurate allocation of
overhead costing that is being faced by many business organization holding manufacturing
facilities. The assignment also describes that the most common reason for which the issue arise is
the use of the traditional costing method where a fixed predetermined overhead rate is being
applied for the allocation of the overhead cost among the different divisions of the organisation.
The assignment advocates in terms of a case study situation that application of activity based
costing and dynamic overhead rate is the most suitable method of resolving the issue.

Table of Contents
Importance of accurate product costing...........................................................................................3
Problems associated with using traditional costing system (used by Beztec).................................3
Cost drivers under activity based costing (ABC)............................................................................3
Cost of each model under ABC costing:.........................................................................................4
Gross profit & gross profit percentage for each model under ABC costing...................................5
Advice to Sue Smith with respect to accounting standard of APES 110 Code of Ethics................6
Causes of over and under allocation of overhead cost while predetermined overhead rate is used 7
Three ways of disposing over and under application of over head allocation.................................9
Conclusion:......................................................................................................................................9
Reference:......................................................................................................................................11
Appendix:......................................................................................................................................12

Importance of accurate product costing
Companies need an accurate product costing systems to track the accurate costs of their
operations and to allocate the costs properly by choosing an appropriate unit. The units that are
often used for allocation of the overhead costs are machine-hour or labour hour. The selection of
an accurate product costing system can represent a manufacturing process represented as
profitable and thus offer the scope to the business to continue with the current manufacturing
process. Otherwise it will not be possible for a business to continue with manufacturing line
having little or no profit margin(DRURY, 2013).
Problems associated with using traditional costing system (used by
Beztec)
In the traditional costing system that is often followed by most of the manufacturing business
organizations the overhead costs are allocated either on the basis of the direct labour hour
consumed or the number of machine hours used. The problem arises with the traditional costing
method when the basis of allocation is much smaller than the amount of cost to be allocated.
The problem become more acute with the costing process when due to a small change in the
volume of resources consumed leads a huge change in the amount of overhead applied per unit
of direct labour hour or machine hour. Thus the issue has become more prominent with the
company Beztec that is engaged in manufacturing operation and is having an automated
production environment and the amount of overhead cost to be allocated is much higher than the
basis that is total machine-hours being used in the operational process(Plank, 2018).
Cost drivers under activity based costing (ABC)
As per the suggestions of Sue smith the Activity Based Costing has been applied where the
major cost drivers that are being identified with respect to the product divisions of Lexon
And Protox under Beztec Limited are Soldering (number of solder points),Shipments (number of
shipments), Quality control (number of inspections), Purchase orders (number of orders,

Machine power (machine-hours), Machine set-ups (number of set-ups).Under the method of
activity based costing the total cost with respect to each Activity-cost driver(that are taking place
in the organization) has been identified. Then the number of activities that are present under each
category of driver has been identified. After that cost per activity has been identified for each
division of the business. Finally the sums of the unit cost of the activities are being calculated for
each division(Kaplan and Porter, 2011).
Cost of each model under ABC costing:
Activity-cost-driver quantities
Activity-cost
driver (driver
quantity)
Total activity
costs Lexon
cost per
activity Protox
cost per
activity Total
Soldering
(number of solder
points) 1165725
133125 8.75662 433152
5
0.269126 1 766
250
Shipments
(number of
shipments)
1064250 18225 58.39506 4275 248.9474 22
500
Quality control
(number of
inspections)
1534500 63225 24.27046 23693 64.76596 87
188
Purchase orders
(number of
orders)
1176120 90113 13.05161 123727 9.505767 213
840
Machine power
(machine-hours)
71280 198000 0.36 18000 3.96 216
000
Machine set-ups
(number of set-
ups)
928125 18000 51.5625 15750 58.92857 33
750
Total production
overhead 5940000 156 386
Operating
income per unit
sold $71.50 $107.25
loss ($84.90)
($279.13
)
Traditional costing
method
Cost of goods
sold per unit $627.00 $877.00
Loss per unit ($555.50 ($769.75

) )
Under the method of ABC costing it can be seen that sums of the unit cost of the activities for
Lexon division is $156 where as that of Protox division is $386.Where as the cost of goods
produced and sold per unit under traditional costing system is $627 under Lexon division and
$877 under Protox division. So the method of ABC costing has substantially reduced the cost
per unit produced and sold and it is expected that profit margin will improve(Zimmerman and
Yahya-Zadeh, 2011).
Gross profit & gross profit percentage for each model under ABC costing
e tec imited A co tinB z L ( BC s g )
ncome tatement or t e inancial ear endedI s f h f y
ecem er31D b 2017
e onL x Protox Total
e en eR v u s 23760000 7524000 31284000
o t o ood old per nitC s f g s s u 156 386
o t o ood oldC s f g s s 3744000 2316000 6060000
ro mar inG ss g 20016000 5208000 25224000
ellin and admini trati e e pen eS g s v x s 6996000 1613700 8609700
peratin incomeO g 13020000 3594300 16614300
nit prod ced and oldU s u s 24000 6000
peratin income per nit oldO g u s $542.50 $599.05
o t o ood old per nitC s f g s s u 156 386
pro it per nitf u $386.50 $213.05
ro pro it mar inG ss f g 84% 69%

Thus it can be seen that application of the ABC costing method has increased the gross profit
margin from 37%(under traditional costing ) to 84% for Lenox division and that of Protox
division from 30%(under traditional costing ) to 69%( Rumble, 2012).
Advice to Sue Smith with respect to accounting standard of APES 110
Code of Ethics
The APES 110 Code of Ethics is issued by the Accounting Professional & Ethical Standards
Board Limited (APESB).The code has come in to effect in 1 July 2011.this code of ethics is must
be followed by the accountants when they are dealing with accounting operations in Public
Interest Entities, partner rotation, non-assurance services, Fees – relative size, compensation and
evaluation policies. Certified accountants in Australia who are working as professional
accountants must comply with the requirements of the code of ethics of APES 110.The
Australian accounting professional who are practicing even outside Australia are required to
comply with this code of ethics to that extent the professional are not prevented from doing so by
specific requirements of local laws and regulations.
One of the important requirements of this code of ethics is that the accounting professional must
act at the best interest of the public as well as entity in which they are working(Jarillo, 2013).
In the present case scenario the accountant is trying to operate at the best interest of the client as
well as public by prescribing the ABC costing method instead of the traditional costing method
as ABC costing method will lead to a better method of cost allocation that will be savings of
costing and enhancement of profit for the business organization and this in turn will help the
business in delivering economic product pricing to the general public. Thus it can be suggested
that by advocating the ABC costing technique instead of traditional costing technique the
accountant is complying with the basic principle of the code of ethics by acting both at the
interest of the organization (in which the accountant is working) as well as public(Martinov-
Bennie and Mladenovic, 2015).
Advice for SUE SMITH:
Thus here the accountant SUE SMITH must convince the CEO Steven Kay that the cost or the
activity drivers has been identified and listed on the basis of the detailed analysis of the operation

of the business Beztec and therefore the calculation of the activity based costing that are being
done are more or less accurate and there is little or no scope of identification of the new activities
or cost drivers that can bring a change in the decision of overhead cost allocation. Moreover SUE
SMITH should place the rational in front of CEO that a comparison and calculation between the
traditional costing method and the AB C costing method that both the gross profit and gross
profit margin has improved for both the divisions of LEXCON and PROTOX under the abc
costing method and the loss per unit with respect to both division has declined under ABC
costing. Therefore SUE SMITH should stick to the decision of implementing the ABC costing
system in the business organization Beztec(Horngren, 2009).
Causes of over and under allocation of overhead cost while
predetermined overhead rate is used
In a traditional costing method where a predetermined overhead rate are used as a basis of
allocation of the overhead cost there is every possibility of over and under allocation of costing
that can be discussed with the help of the following example.
Let as assume that in business-X there are two divisions; division-A, division-B., The division-A
is a high value product line and the division-B is a low value product line. The business-X has
estimated that total machine hours of 20,000 units will be used and the estimated overhead cost
to be used is $2,000,000. In such a situation the predetermined rate that will exist in the
organization is $100 per machine hour. Thus if this predetermined overhead rate is applied then
in case of division-A the total overhead cost to be applied is $150,000(assuming the division is
using a total machine hours of 1500 units).Again as per the predetermined rate division-B the
total overhead cost to be applied is $50,000 (assuming the division is using a total machine hours
of 500 units).Thus it can be seen that being a high value division, division-A has required $150
per machine hour and being a low value division-B requires $90 per machine hour(Cai et
al.,2009).
According to this rate Division-A will account for the overhead cost of ($150*1500machine
hours) =$ 2, 25,000 and Division-B will account for the overhead cost of ($90*500machine
hours) =$ 45,000. Thus it can be seen that when the predetermined overhead rate of $100 per
machine hour has been used then an under absorption or allocation of cost have occurred in case

of the high value division or Division-A and an over allocation of cost have occurred in case of
low value division of Division-B(Noreen et al., 2014).
Business-X(manufacturing company)
portion of
overhead cost
allocated
Actual overhead
rate that should be
applied per
machine hour($)
portion of
overhead cost
allocated
High value division,
Division-A, using 1500
machine hours
150000 8
%
150 $22500
0
11%
Low value division,
Division-B, using 500
machine hours
50000 3
%
90 $45000 2%
Total overhead cost to
be allocated
$2,000,000
Total estimated machine
hour to be used by the
business
20000
Predetermined over
head rate
$100
Thus in case of fixed pre-determined overhead rate 8% of the total overhead cost has been
allocated to the high valued division-A & 3% of the total overhead cost has been allocated to the
high valued division-B.
But in case when the different rate of overhead cost has been applied to Divisions-A &
Division-B as per the requirement of the divisions then it can be seen that 11% of the total
overhead cost has been allocated to division-A and 3% of the total overhead cost has been
allocated to division-B.
Thus it can be seen that a clear under allocation of cost has occurred in case of Division-A and
over allocation of cost has occurred in case of Division-B when the fixed predetermined
overhead rate has been applied.

Three ways of disposing over and under application of over head
allocation
The following method or ways can be applied for the disposition of the under or over application
of over head cost:
Dynamic ABC costing method:
In this .method the business should identify the cost drivers as well as the number of activities as
well as total overhead cost to be allocated to that cost driver just from the scratch for every new
accounting period so that the business can use a changing overhead rate per activity instead of a
predetermined overhead rate with respect to the each cost driver .This procedure will definitely
help the business to dispose the over and under application of over head with respect to the listed
drivers of cost being freshly identified in each new accounting periods as per the changing
requirements of the business.
The other method of disposing the over or under application of overhead is “closed out to cost
of goods sold”. Under this method the balance of the manufacturing overhead is being closed out
to the cost of goods sold account (Walther and Skousen, 2009).
The third method of disposing the under or over applied manufacturing overhead is the
allocation of the balance overhead between work in process (WIP), finished goods and cost
of goods sold in proportion to the overhead applied during the current period
Conclusion:
The discussion and calculations of the assignment suggests that it is quite inappropriate to use a
fixed overhead rate which is determined well is advance for the different divisions or product
lines of the organization that are operating in different scales of operations(Garrison et al.,2010).
The use of a predetermined over rate often leads to over and under application of costs for the
different division of the organization and also affects the profit margin of the organization. In
such a situation the best option that is available to the accountant of an organization is the use of

activity based costing where the identification of cost drivers and overhead rates should vary
from one accounting period to another with the changing business activity

Reference:
Cai, J., Liu, X., Xiao, Z. and Liu, J., 2009. Improving supply chain performance management: A
systematic approach to analyzing iterative KPI accomplishment. Decision support
systems, 46(2), pp.512-521.
DRURY, C.M., 2013. Management and cost accounting. Springer.
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial
accounting. Issues in Accounting Education, 25(4), pp.792-793.
Horngren, C.T., 2009. Cost accounting: A managerial emphasis, 13/e. Pearson Education India.
Jarillo, J.C., 2013. Strategic networks. Routledge.
Kaplan, R.S. and Porter, M.E., 2011. How to solve the cost crisis in health care. Harvard
Business Review, 89(9), pp.46-52.
Martinov-Bennie, N. and Mladenovic, R., 2015. Investigation of the impact of an ethical
framework and an integrated ethics education on accounting students’ ethical sensitivity and
judgment. Journal of Business Ethics, 127(1), pp.189-203.
Noreen, E.W., Brewer, P.C. and Garrison, R.H., 2014. Managerial accounting for managers.
New York: McGraw-Hill/Irwin.
Plank, P., 2018. Introduction. In Price and Product-Mix Decisions Under Different Cost
Systems (pp. 1-5). Springer Gabler, Wiesbaden.
Rumble, G., 2012. The costs and economics of open and distance learning. Routledge.
Walther, L.M. and Skousen, C.J., 2009. Managerial and cost accounting. Bookboon.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and
control. Issues in Accounting Education, 26(1), pp.258-259.

Appendix:
e tec imited Traditinal co tinB z L ( s g )
ncome tatement or t e inancial ear endedI s f h f y
ecem er31D b 2017
e onL x Protox Total
e en eR v u s $23 760 000
$7524
000 $31 284 000
o t o ood oldC s f g s s 15 048 000
5 266
800 20 314 800
ro mar inG ss g 8 712 000
2 257
200 10 969 200
ellin and admini trati e e pen eS g s v x s 6 996 000
1 613
700 8 609 700
peratin incomeO g $1 716 000 $643 500 $2 359 500
nit prod ced and oldU s u s 24000 6000
peratin income per nit oldO g u s $71.50 $107.25
o t o ood old per nitC s f g s s u $627.00 $877.00
o per nitL ss u ($555.50) ($769.75)
Total loss ($) -13332000 -4618500
ro mar in nder traditional co tinG ss g u s g
e onL x Protox
e en eR v u s
2376000
0
752400
0
o t o ood oldC s f g s s
1504800
0
526680
0
ro mar inG ss g 8712000
225720
0
ro mar inG ss g
percenta eg 37% 30%