Conventional vs. Activity-Based Costing

This assignment explores the application of conventional and activity-based costing methods to determine product costs for two types of office desks produced by Sunrise Ltd., Executive and Elite. It examines the cost breakdown, overhead allocation, and impact on product pricing under each method. The analysis highlights the differences in indirect cost allocation based on activity drivers and demonstrates how ABC can provide a more accurate representation of product costs compared to traditional methods.

[Type the company name]
Management Accounting

Sunrise Ltd. Produces two types of office desks namely Executive and Elite desks. The
company uses traditional method of costing for allocating indirect overheads to products. The
company uses machine hours to allocate indirect costs.
a) The per unit product cost using conventional costing
Pre-determined overhead rate = total manufacturing overhead / estimated number of machine
hours
= $240,000 / 8000
= $30
The product cost per unit using the conventional costing system:
Particulars Executive Elite
Cost of material per desk $200 $300
Direct labour costs per desk $180 $410
Machine hours per desk $10 $10
Overhead rate
$30
Indirect cost $300 $300
Product cost per unit $680 $1,010
b) Now the company is considering activity based costing system to allocate manufacturing
overheads to the products. Three activities have been identified. The cost of each activity is
calculated below:
Activity
Total
Costs
Cost allocation
base
Level of
cost
driver
Cost per
activity
Design
$100,00
0 Design hours 4000 $25
Set ups $65,000
Number of set
ups 50 $1300
Machine operations $75,000 Machine hours 5000 $15
The indirect cost allocation for each product is presented as follow:

Activity
Quantity of cost
allocation base Indirect cost
Indirect cost per
desk
Executive Elite
Executive
(Cost
driver*cost per
activity)
Elite
(Cost
driver*cost
per activity)
Executiv
e Elite
Design
800
design
hours
3200 design
hours $20,000 $80,000 $67 $400
Set ups 10 setups 40 setups $13,000 $52,000 $43 $260
Machine
operations
3000
machine
hours
2000
machine
hours $45,000 $30,000 $150 $150
Total $78,000 $1,62,000 $260 $810
Estimated product cost per unit under activity based costing:
Particulars Executive Elite
Cost of material per desk $200 $300
Direct labour costs per
desk $180 $410
Indirect cost $260 $810
Product cost per unit $640 $1,520
c) From the above analysis the costs per desk of Executive and Elite are:
Executive per unit cost Elite per unit cost
Conventional Costing $680 $1010
Activity based costing $640 $1520
We see that the cost of per unit executive desk has decreased whereas the per unit cost of elite
desk has increased. This is primarily due to the allocation of the indirect overheads under
both the costing systems. The direct material and direct labour is the same under both the
methods. The per unit overhead costs for both desks under the two methods is:
Executive (per unit overhead) Elite(per unit overhead)
Conventional Costing $300 $300
Activity based costing $260 $810

Both the desks use same number of machine hours under conventional costing, hence equal
overheads were allocated. However, under activity based costing, the total indirect costs have
been divided into three activities cost i.e. design, setup and machine operations costs. For
each of these activities, a cost driver has been identified and depending on the usage of these
activities by each desk, the cost of each activity for both desks has been arrived at and the
total of activity cost is the allocated indirect cost (Eldenburg, Brooks, Oliver, Vesty, Dormer,
& Murthy)We see that set up is the most expensive activity costing $1300 per set up.
Executive requires only 10 set ups whereas elite requires 40 set ups, thus the set up cost for
Elite is higher. Similarly design hours required by elite is higher and the cost per design hour
is higher than the machine hour cost. Only the machine hours required for machine
operations (least expensive) is higher for executive, hence executive has an overall lower
indirect costs allocated to it.
Bibliography
Eldenburg, L., Brooks, A., Oliver, J., Vesty, G., Dormer, R., & Murthy, V. (n.d.). Managment
Accounting: 3rd Edition. Australia: Wiley.