Cost Accounting Assignment: Comparing Costing Methods and Analysis

This assignment solution demonstrates the calculation of cost per unit for two products, Fred and Martha, using both conventional and activity-based costing (ABC) methods. The conventional approach utilizes a predetermined overhead rate based on direct labor hours, while ABC allocates overhead based on specific activities and cost drivers, such as machine hours and the number of production runs. The solution includes detailed calculations of overhead rates, cost per unit under both methods, and a comparison highlighting the differences in cost allocation. The analysis reveals that the conventional method can lead to under- or over-costing due to its reliance on a single allocation base, whereas ABC provides a more accurate representation of costs by considering the actual resources consumed by each product. Furthermore, the assignment discusses the advantages of ABC, such as process improvement, scientific cost allocation, and competitive pricing, while also acknowledging its disadvantages, including high implementation costs, data accuracy concerns, and the lengthy implementation process. The solution concludes by comparing the selling prices of the products under ABC and emphasizes the importance of accurate cost allocation for effective management decision-making.

(a) Calculation of cost per unit of products using the conventional approach
Particulars Fred Martha
Direct Material 40 60
Direct Labour 30 45
Manufacturing overhead (refer WN-1) 96 144
Cost per unit 166 249
WN-1 Calculation of predetermined overhead rate:
Total Budgeted Manufacturing Overhead = $816,000
Allocation basis = Direct Labour Hours
Predetermined Overhead Rate = Budgeted Manufacturing Overhead/Direct Labour Hours
Predetermined Overhead Rate (per hour) = $816,000/17,000
Predetermined Overhead Rate (per hour) = $48
Calculation of Direct Labour Hours
Particulars Units Hour per unit Total
Fred 1,000 2 2,000
Martha 5,000 3 15,000
Total Direct Labour Hours 17,000
(b) Calculation of cost per activity using Activity Based Costing
Overheads Cost driver
Budgeted
Level
Overhead
Amount
Cost per
activity
Machine related costs Machine hours 9,000 450,000 50
Setup and inspection Number of production runs 40 180,000 4,500
Engineering Engineering change order 100 90,000 900
Plant related costs Square footage of space 1,920 96,000 50
816,000 5,500

(c) Calculation of cost per unit of products using the Activity Based Costing
Particulars
Fred Martha
Units Rate per
unit Total Units Rate per
unit Total
Direct Material 1,000 40 40,000 5,000 60 300,000
Direct Labour 1,000 30 30,000 5,000 45 225,000
Manufacturing overhead
Machine related costs 4,000 50 200,000 5,000 50 250,000
Setup and inspection 20 4,500 90,000 20 4,500 90,000
Engineering 75 900 67,500 25 900 22,500
Plant related costs 1,536 50 76,800 384 50 19,200
Total Costs 504,300 906,700
No. of Units 1,000 5,000
Cost per unit 504.30 181.34
Cost per unit (rounded off) 500.00 180.00
WN-1: Calculation of activity consumed by each product
Overheads Cost driver Budgete
d Level
Overhead
Amount
Cost per
activity
Activity Required
FRED MARTHA
Machine related costs Machine hours 9,000 450,000 50 4,000 5,000
Setup and inspection Number of production runs 40 180,000 4,500 20 20
Engineering Engineering change order 100 90,000 900 75 25
Plant related costs Square footage of space 1,920 96,000 50 1,536 384
816,000 5,500 5,631 5,429
(d) Calculation of Selling Price under Activity Based Costing
Particulars FRED MARTHA
Cost per unit 500 180
Add: Profit Margin 100 36
Selling Price 600 216

(e) Under conventional approach, the costs are allocated using a plant wide allocation rate, without
considering the actual resources consumed. Plant wide allocation rate is calculated by dividing the total
overhead with a common base, say it, direct labour hours or any other base as decided by the management
(Bragg, 2017). This approach does not take care about actual consumption of resources and thus does not
give the true picture of costs. Whereas under ABC the costs are allocated on the basis of actual resources
used in manufacturing and thus a reliable way of costing the products.
Under the above scenario, the cost of FRED under conventional approach is $166 and cost of MARTHA
is $249 which is calculated by allocating the manufacturing overhead using a predetermined overhead
rate calculated on the basis of direct labour hours. Thus, the overhead are allocated by dividing total
manufacturing overhead of $816,000 with direct labour hours consumed in manufacturing of products,
i.e. 2 hours per unit in case of product “FRED” and 3 hours per unit in case of product “MARTHA”.
On the other hand, under activity based costing the cost of product “FRED” is $ 500 and the cost of
product “MARTHA” is $ 180. Under activity based costing, the overheads are allocated on the basis of
actual resource consumed by each product. For example, total machine related cost is $450,000 which is
to be allocated on the basis of machine hours thus, the cost per activity comes to $50. The FRED has used
4000 machine hours and MARTHA has used 5000 machine hours. Thus, overhead allocation of machine
costs comes at $200,000 for FRED and $250,000 for MARTHA.
Thus, we can clearly elaborate that under conventional approach the FRED was under costed by $334 per
unit and MARTHA was over costed $69 due to allocation of overheads using a single blanket rate and
ignoring the actual resources consumed.
(f) Activity based costing has many benefits, some of them are listed below (Bright Hub, 2017):
a. Improvement in Process – Activity Based Costing involves looking in various processes and
checking their workings to allocate the cost in a meaningful way. Thus, checking all the process
reveals any discrepancies in those processes and thus helps in improving the process by identifying
the problems.
b. Scientific Method of cost allocation – Activity based costing is a scientific method for cost allocation
which provides accurate results provided the data inputted is accurate. Further, it also helps in
improving costs and processes and reducing or eliminating non value added costs or processes.
c. Competitive pricing - Activity based costing allocates the costs according to the use of resources by a
particular product. When the costs are allocated according to the usage of resources, it gives true and
accurate picture of the cost involved in the product. And thus helps the management in making the
pricing strategies and keeping the price competitive.
d. Identification of cost on each level – Activity based cost helps in allocating the cost on a systematic
basis, thus cost can be allocated and identified at each process level. For example, manufacturing of
a product is done in 2 departments, assembly department and manufacturing department. So, the cost

can be identified when the product is transferred from assembly department to manufacturing
department and so on.
(g) Every method has some pros and cons. The following are the disadvantages of using activity based
costing (Bright Hub, 2017):
a. Extreme Implementation costs -Application of Activity Based Costing involves high cost of
implementation, experts need to be appointed for proper and successful implementation for this
costing method. Sometimes, the savings in cost due to implementation of Activity Based Costing is
not much to cover its implementation costs.
b. Flaws in Data - Activity Based Costing requires input data to be collected from various departments.
The entire implementations and results depend upon these input data. If these data contain any flaw,
then the implementation of Activity Based Costing will be of no use as it will not show the correct
results. So, for using Activity Based Costing the accuracy of data is of utmost priority.
c. Lengthy process - Implementation of activity based costing is a time consuming and a lengthy
process. It involves lots of time in collecting, examining and verifying the input data and including
those data in the systems.
References:
Bright Hub. (2017). Activity Based Costing Advantages and Disadvantages. [online] Available at:
http://www.brighthub.com/office/finance/articles/78752.aspx [Accessed 12 Sep. 2017].
Bragg, S. (2017). Traditional costing. [online] AccountingTools. Available at:
https://www.accountingtools.com/articles/what-is-traditional-costing.html [Accessed 12 Sep. 2017].