Costing Analysis: Traditional and ABC Costing

This report provides a detailed analysis of traditional and activity-based costing methods. It includes calculations of cost per unit, income statements, and importance of accurate product costing. The report also discusses overheads, applied overheads, and methods to deal with under or over applied situations.

Running Head: COSTING ANALYSIS
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Costing Analysis
Traditional and ABC Costing

COSTING ANALYSIS
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Table of Contents
Answer to Question-1................................................................................................................2
Answer to Question-2................................................................................................................4
Answer to Question-3................................................................................................................7
Analysis................................................................................................................................10
Importance of accurate product costing...............................................................................10
Answer to Question 4...............................................................................................................11
Answer to Question 5...............................................................................................................12
Bibliography.............................................................................................................................14

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Answer to Question-1
Particulars Basic Model Advance Model
Units Produced and sold 1700 1600
Direct Material cost per unit 350 580
Direct Labor cost per unit 175 280
Total 525 860
Calculation of cost per unit under traditional method
Particulars
Basic Model Advanced
Model
Direct Material cost per unit 595000 928000
Direct Labor cost per unit 297500 448000
Total overhead costs 160488 119512
other overheads 383500
Total 1052988 1495512
units produced 1700 1600
619 935
Traditional costing
Costing is the act of breaking down the costs and analysing the individual constituents and
preparing a report to be submitted to the management of the company. The analysis of the
costing is necessary to understand the impact of the costs on the earnings of the company and
rectifying the same if there is any need. The methods to measure the overhead costs are the
traditional method, activity based costing, prorated based costing. All the three methods have
been described in this report and a detail analysis is done in this report (Manunen, 2013).
Traditional costing is the method under which the factories overheads are allocate on the
basis of the volume of the total resources produced. Generally under this method the
overheads are assigned taking the labour hours or the machine hours as the base. Above is the

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table in which the cost per units is calculated by using the traditional method. The overhead
cost is calculated using the machine hours therefore the figure of $615 and $935 is arrived
after dividing the total indirect overhead costs by the machine hour. Further the second table
displays the cost per unit taking into consideration the cost of the direct labour materials per
unit and the labour per unit (Patiar, 2016).
Answer to Question-2
Calculation of cost per unit under activity based costing method
Particulars Basic Model Advanced Model
Direct Material cost per unit 350 580
Direct Labor cost per unit 175 280
Overhead costs per unit 52 120
Other operating Expenses 383500
Operating Expenses per unit 240
Total cost per unit a 577 1220
Working note of Overheads
Indirect Overheads
Cost
Estimated
cost Driver
Activity
Ove
rhea
d
Rate
Alloca
tion of
overh
ead
costs
Allocat
ion of
overhe
ad
costs
Inspection (hours) 30000 Inspection 970 31 210 6495 760 23505
Assembly (direct
machine hours)
10000
0 Assembly
820
0 12
470
0 57317 3500 42683
Production Scheduling
11000
0
Production
Scheduling 570 193 60 11579 510 98421
Machine set up 40000
Machine Set-
up 390 103 120 12308 270 27692
Total 87699 192301
Manufacturing
overhead cost**
Total overhead cost/ no
of units produced 52 120

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Activity based costing model
Activity based costing method is the method which is mainly featuring the costs to overhead
activities and thereafter the costs are segregated on the basis of their relevant products. This
method showcases the relationship between the costs, overhead activities and the products so
manufactured. Under this method the individual overhead rate is assigned to the
manufacturing overhead. For example the inspection rate is calculated by dividing the
inspection cost by the inspection driver to get the overhead rate. Similar is the case for all the
other indirect manufacturing costs (Freiesleben, 2014).
Selling price Advance model
Cost plus 30% 1215.10
Further it can be observed from the above table that the selling price of the advance model is
cost plus 30% which equals to the cost of the advanced model in the activity based costing at
$1220 and this lures the attraction of the overseas buyer to buy the advanced model under the
current system which is known as the traditional based costing system (Innes and Mitchell,
2015).
Answer to Question-3
Traditional Costing System
Sewing Easy
Income Statement
For the year ending 31st March 2017
Particulars Advanced
Model
Amount

COSTING ANALYSIS
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Sales 1944166
Cost of goods sold
Direct
materials 928000
Direct labors 448000
overheads 503012
Total Expenses 1879012
Gross Profit 65154
Net Income 65154
Activity Based Costing System
Sewing Easy
Income Statement
For the year ending 31st March 2017
Particulars Advanced
Model
Amount
Sales 1944166
Cost of goods sold
Direct
materials 928000
Direct labors 448000
overheads 575801
Gross profit 1951801
Total -7636
Net Income -7636

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Analysis
From the calculations above it can be stated that the cost per unit under the traditional method
is $619 and $935, whereas in case of the activity based costing model the cost per unit of the
basic model is $577 and the $1220 for the advanced model. The interest of the overseas buyer
is more towards the advanced model as the advanced model would cost less under the
traditional based costing system and will provide the difference of $285, whereas in activity
based costing method the price of the advanced model is $1220 which is costly for the
overseas buyer hence he is more interested in the lower price (Plank, 2018). Also if the
overall overhead cost is reviewed from the profit and loss account the company is earning
profit under the traditional costing method, and facing losses in case of the activity based
costing henceforth the interest of the buyer is more towards the traditional costing.
Importance of accurate product costing
Accurate product costing helps in assisting the products and lets the investor makes important
decisions of the business easily. The accurate product costing helps the users of the financial
statements in the different manner. For example the importance of the accurate costing for the
investors can be with regard to the information of the net worth and for the managers of the
company the information regarding the earnings will be of core importance. This also helps
the managers to take the decisions accurately. The accurate product costing is the only
method which is a reliable method and which helps in checking the profitability of the
business. Moreover the gross profit margin can be measured along with the valuation of the
assets and the optimal choices. The management can formulate the strategies to gain the
competitive advantage and stay longer in the game of the survival. The accurate product
costing will help to check the authenticity and the accuracy of the product costing; otherwise

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the operations of the business will fall in the category of the grey areas (Haddadi and
Seyednezhad, 2015).
Answer to Question 4
In accounting the term overhead refers to the indirect manufacturing costs. These
manufacturing costs are those costs that are apart from the regular ad the direct costs. The
applied overhead is the overhead where the indirect costs relating to the manufacturing have
been assigned to manufactured goods. This overhead is generally applied on the basis of the
predetermined overhead rate (Vaxevanidis and Petropoulos, 2018). The actual overhead
refers to the indirect manufacturing costs that have been occurred actually. The example of
such costs is gas, electricity, rent, water, property, depreciation, repairs and other regular
indirect costs (Accounting Coach 2018).
By the definition it can be fixed that the overhead cannot be traced correctly, most of the
companies therefore make use of the overhead already decided instead of the actual
overheads due to the following reasons.
There are certain costs such as the factory building depreciation which are fixed in nature.
The possibility here arises a lot in case of the variation of the rates on the monthly basis and
on the other hand the actual overhead rate varies. In this case there is no balance between the
predetermined rate and the actual rate (Tsai, 2016).
Furthermore, if excessive overheads are assigned to the jobs then they are called as the over
applied whereas the reverse of the same is termed as the under applied. The situation of the
over applied arises when the amount of the cost of goods sold is more and the same has been
included in the amount of the overheads and the reversal of the situation falls under the
category of the under applied. Further for the purpose of understanding the company opens

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up the account of the factory overhead is created and the application of the work in progress
is credited to the same (Dale and Plunkett, 2017).
There are certain methods to deal with the under or the over applied situations which have
been outlined below.
 There is a carry forward of the amount into the period belonging to next financial year
 Secondly an entry to write off the amount to the profit and loss account can be passed.
 For bringing the positive changes a supplementary rate can be utilised (Pitel and
Alioshkina, 2016).
Answer to Question 5
Actual
Overhead
Applied
overhead
300000 210000
Account
balance
Account
balance
before
Proration
After
Proration
Work in
progress 60500 3% 9073 6351 75924
Finished Goals 90000 4% 13497 9448 112944
cost of goods
sold 1850000
92
% 277431 194201 2321632

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Total 2000500 300000 210000 2510500
For the purpose of the report the most consistent and the accurate amount of the inventory
and the cost of goods sold, the most preferential method is the prorated method under which
the balances of the work in progress, the finished goods and the cost of goods sold are written
in the vertical format. The first heading made is of the account balances before the proration
method (Plunkett and Dale, 2018). Each figure is calculated in terms of the percentage of the
total amount of all the three figures and thereafter the percentage value is multiplied with the
value of the respective overhead. Under this situation the actual overhead is $300000 and the
applied overhead is the $210000. The percentage value is multiplied with the respective
values of the overhead and finally the summation of all three figures is calculated to arrive at
the total figure termed as the account balance after the proration method (Christopher, 2016).

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Bibliography
Accounting Coach (2018) What is the difference between actual overhead and applied
overhead? [online] https://www.accountingcoach.com/blog/dfifference-actual-overhead-
applied-overhead [Accessed on 15th January 2018].
Christopher, M., 2016. Logistics & supply chain management. Pearson UK.
Dale, B.G. and Plunkett, J.J., 2017. Quality costing. Routledge.
Freiesleben, J. (2014) On the limited value of cost of quality models, Total Quality
Management and Business Excellence, 15(7), 959-969.
Haddadi, D. and Seyednezhad, M., 2015. Comparative study of traditional and activity-based
costing in forging companies of Iran tractor.
Innes, J. and Mitchell, F., (2015) A survey of activity-based costing in the UK's largest
companies, Management accounting research, 6(2), pp.137-153.
Lee, J., Park, M., Lee, H.S., Lee, K.P. and Hyun, H., 2015. Application of Activity-Based
costing (ABC) for Modular Building Construction Indirect Costs Calculation at the
Manufacturing Stage. Korean Journal of Construction Engineering and Management, 16(4),
pp.139-145.
Manunen, O. (2013) An activity-based costing model for logistics operations of
manufacturers and wholesalers, International Journal of Logistics, 3(1), 53-65.
Patiar, A., (2016) Costs allocation practices: Evidence of hotels in Australia, Journal of
Hospitality and Tourism Management, 26(1), pp.1-8.

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Pitel, N.Y. and Alioshkina, L.P., (2016) ABC analysis as a tool of optimization of marketing
management of export-led enterprises, New York: Springer.
Plank, P., 2018. Introduction. In Price and Product-Mix Decisions Under Different Cost
Systems (pp. 1-5). Springer Gabler, Wiesbaden.
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quality’models, The International Journal of Production Research, 26(11), 1713-1726.
Tsai, W.H., (2016) Activity-based costing model for joint products, Computers & Industrial
Engineering, 31(3), pp.725-729.
Vaxevanidis, N. M., and Petropoulos, G. (2018) A literature survey of cost of quality
models, Journal of engineering, 6(3), pp. 274-283.