Costing of Sewing Machine Models using Traditional and Activity Based Costing

MANAGEMENT ACCOUNTING
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Table of Contents
Introduction................................................................................................................................2
Analysis......................................................................................................................................2
Traditional Costing.................................................................................................................2
Activity Based Costing...........................................................................................................4
Income Statement.......................................................................................................................6
Under-application and over-application of overheads...............................................................8
Under-applied/Over-applied Overhead......................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
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Introduction
Fantori Ltd is a company that manufactures sewing machine in two models namely the basic
model and advanced model. The traditional costing method is used by the company for
product costing where the overhead cost is allocated between the two models on the basis of a
direct cost. The company is about to enter into a new phase as a foreign buyer has shown
interest. However, this buyer has shown interest only in the advanced model and not in the
basic model which is rather surprising. Tony Mans suspects that the primary reason for the
strange pattern of interest by the foreign buyer may be linked to the use of traditional costing
system which might be providing inaccurate cost estimate thus making the prices of the
model skewed. In this background, the objective is to report is to carry out the costing of the
two models of sewing machine using both traditional and Activity Based costing (ABC) so as
to advice if there has been an under-application or over-application of overhead to the two
models. Also, the importance of accurate product costing and pricing would also be dealt by
the given report.
Analysis
This section presents the analysis of the data provided in the context of the problem at hand
and the objective at hand.
Traditional Costing
The various details pertaining to the costing of the two models has been offered and using the
same the unit price of each model would be determined as per the traditional costing. A key
feature of the traditional costing method is that the indirect cost allocation is linked to one of
the direct costs (Damodaran, 2015). As per the company practice, machine hour is used as the
measure to drive the indirect cost allocation between the two models.
Step 1: Computation of direct costs per unit
Model 1: Basic Model
Unit material cost = $ 350
Unit direct labour cost = $ 175
Total direct cost per unit = 350 +175 = $ 525
Model 2: Advance Model
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Unit material cost = $ 580
Unit direct labour cost = $ 280
Total direct cost per unit = 580 +280 = $ 860
Step 2: Allocation of indirect costs per unit
The basis of allocation of indirect costs would be on the basis of the total machine used for
the production of two models.
Total indirect cost = Inspection ($30,000) + Assembly ($ 100,000) + Production Scheduling
($110,000) + Machine Set up ($40,000) = $ 280,000
Total machine hours used for the production of the two products = 4700 + 3500 = 8,200
hours
Indirect cost per unit machine hour = (280000/8200) = $ 34.146
Indirect cost allocated to the production of the basic model = 4700*34.146 = $ 160.488
Indirect cost allocated to the production of the advance model = 3500*34.146 = $ 119.512
Based on the given information, units of production of basic model = 1700
Unit indirect cost allocated to basic model = (160488/1700) = $ 94.40
Based on the given information, units of production of advance model = 1600
Unit indirect cost allocated to advance model = (119512/1600) = $ 74.70
Step 3: Unit cost as per traditional costing
Unit cost of a model = Unit direct cost + Unit indirect cost
Unit cost of basic model = 525 + 94.40 = $619.40
Unit cost of advance model = 860 + 74.70 = $934.70
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