Comparative Cost Analysis of Sewing Easy Ltd. Models

This assignment solution analyzes cost accounting methods for Sewing Easy Ltd. It begins by calculating the cost per unit using the traditional costing method, allocating indirect costs based on machine hours. Then, it calculates the cost per unit using activity-based costing (ABC), identifying cost drivers for more accurate overhead allocation. The solution includes profit and loss statements for the Advance model using both methods, followed by an analysis of an overseas buyer's purchasing behavior. It also explains the difference between actual and applied overheads, discussing ways to deal with over or under-applied overheads. Finally, it highlights the advantages and disadvantages of ABC, emphasizing its accuracy, transparency, and cost management benefits, while acknowledging its complexity and cost.

Solution-1
Calculation of cost per unit under the current traditional costing system
The Sewing Easy Ltd allocates the indirect cost using traditional method basis on machine hours.
For this, firstly the predetermined overhead rate needs to be computed for allocation of indirect
costs to the product. The formula for calculating the predetermined overhead rate is as below:
Predetermined Overhead Rate = Total Indirect Overhead/ Total Machine hours
Hence, the predetermined overhead rate of the company is $31.25 (250,000/ 8000).
Now, the next step is to allocate the indirect overheads to products using above calculated
predetermined overhead rate.
Particulars Basic Advance
Total machine hours 4,600 3,400
Units produced and sold 1,600 1,500
Machine hour per unit (total machine
hours/ unit produced and sold) 2.88 2.27
Overhead per unit 89.84 70.83
Hence, the cost per unit of the models is as below:
Particulars Basic Advance
Direct material cost 325.00 560.00
Direct Labor cost 150.00 260.00
Allocated indirect overheads 89.84 70.83
Other costs* (201,700/1,500) 134.47
Total cost per unit 564.84 1,025.30
*Other costs includes the following costs directly attributable to Advance Model.
Selling & Admin expense 140,600
Interest expense 25,200
Office rent 35,900
Total expense 201,700
Hence, the cost per unit for Basic Model is $564.84 and for Advance Model is $1,025.30.

Solution-2
Calculation of cost per unit under the current activity based costing system
ABC or activity based costing system is the system for allocation of costs to the product on the
basis of activities or resources consumed by the respective product. It is a more practical method
and generally provides the accurate results. For allocation of costs under this system, first of all,
the cost drivers are identified and then the costs are allocated on the basis of cost drivers
consumed by respective products.
The calculation of allocation of indirect costs to product as per ABC is as below:
Particulars
Indirect
Overhead
s
Activities Consumed Cost allocation
Basic
Model
Advance
Model Total Cost
Driver
Cost
per
activity
Basic
Model
Advanc
e Model
Inspection 20,000 200 750 950
Inspection
s 21.05 4,211 15,789
Assembly 90,000 4,600 3,400 8,000
machine
hours 11.25 51,750 38,250
Production
scheduling 105,000 50 500 550 Runs 190.91 9,545 95,455
Machine set-up 35,000 100 250 350 set up 100.00 10,000 25,000
Total Costs 250,000 75,506 174,494
No. of units 1,600 1,500
Cost per unit 47.19 116.33
Hence, the cost per unit of both the products is as below:
Particulars Basic Advance
Direct material cost 325.00 560.00
Direct Labor cost 150.00 260.00
Allocated indirect overheads 47.19 116.33
Other costs* (201,700/1,500) 134.47
Total cost per unit 522.19 1,070.80
Hence, the cost per unit for Basic Model is $522.19 and for Advance Model is $1,070.80.

Solution-3 (a)
December 2017 Profit and Loss Statement for the advance model using traditional costing
Particulars Units Per unit Amount ($)
Sales * 1,500 1,230 1,845,000
Expenses
Direct material cost 1,500 560 840,000
Direct Labor cost 1,500 260 390,000
Overhead cost 1,500 70.83 106,245
Other expenses
- Selling & Admin expense 140,600
- Interest expense 25,200
- Office rent 35,900
Net Profit 307,055
* The selling price per unit is 20% plus cost. Hence, the selling price per unit is $1,230
(1025.30*120%).
Solution-3 (b)
December 2017 Profit and Loss Statement for the advance model using ABC
Particulars Units Per unit Amount ($)
Sales * 1,500 1,285 1,927,433
Expenses
Direct material cost 1,500 560 840,000
Direct Labor cost 1,500 260 390,000
Overhead cost 1,500 116.33 174,494
Other expenses
- Selling & Admin expense 140,600
- Interest expense 25,200
- Office rent 35,900
Net Profit 321,239
* The selling price per unit is 20% plus cost. Hence, the selling price per unit is $1,285
(1070.80*120%).

Analysis of Overseas buyer behavior of purchasing advance model only
The traditional method allocates the overhead on the basis of common allocation resource be it
labor hours or machine hours. This method does not take into account the actual usage of that
common resource by the products. Hence, it allocates the cost on the basis of blanket rate and
usually does not provides the accurate results.
On the other hand, the activity based costing allocates the overhead on the basis of actual
resources consumed by the products and hence generally provides the accurate results.
Let’s compare the cost of the two products under above two defined methods.
The cost of the two products under traditional costing is $565 for Basic Model and $1,025 for
Advance Model whereas the cost of the products under activity based costing is $522 for Basic
Model and $ 1,071 for Advance Model. Hence, it can be seen that the Basic Model is overpriced
by $43 ($565-$522) and the Advance Model is underpriced by $45 ($1025-$1071).
Since, the Advance model is underpriced than its actual price and might be possible that the
Advance product is not available in the market at this price, since it is underpriced. That’s why
the overseas buyer is interested in buying the advance product as it is underpriced and further,
they are not interested in buying the basic product as it is overpriced.

Solution-4
The actual overheads refers to the amount of indirect overheads actually incurred by the
business. The indirect overheads are those overheads which cannot be directly allocated to the
products. Like factory rent, electricity of factory, supervisor’s salary, etc.
On the other hand, the applied overheads are those overheads which have been applied to the
products using predetermined overhead rate which is calculated by dividing the estimated
indirect overheads with estimated machine hours or labor hours. These applied overheads usually
differs from actual overheads as the overheads used for the calculation of applied overheads are
estimated and when the overheads are incurred in actual then they differs from estimated one.
However, rarely it happens that the applied overheads and the actual overheads are the same.
This is when the estimates becomes actuals. That is, the estimated overheads are same as actual
overheads and the estimated machine or labor hours are the same as actual machine or labor
hours.
The three ways to deal with over or under applied overheads are:
(a) Supplementary rate – To calculate a supplementary rate on the basis of difference
between applied and actual overheads and then using this supplementary rate the
difference is charged to the products.
(b) To write off – The difference of applied and actual overheads can also be directly written
off to the profit and loss account.
(c) Carried forward – the amount of difference between actual and applied overheads can be
carried forward to the next year and can be settled off in the next year itself.
Solution-5
The ABC is a very popular method and has the following advantages: (Money Matters | All
Management Articles, 2018)
(a) Accurate product cost – The product cost calculated using ABC are generally accurate.
Since, the ABC method is a realistic method and works on the practical base, i.e. on the
basis of cost drivers and activities actually consumed by the products. Hence, ABC
provides more realistic product cost.
(b) Tracing of overheads – Under ABC, the overheads are traced as per their cost drivers,
which makes the process transparent and more reliable. Hence, the overheads can be
easily allocated to the products.
(c) Cost Management – Since, the overheads are traced with the transactions, hence
managing costs become easy and the management can easily decides which is the
avoidable cost and can be reduced without affecting the whole production process. On the

basis of these information, it becomes easier for the management to make various
decisions and productivity improvement approaches.
(d) Multiple products – the ABC is best to use when the business manufactures multiple
products.
Apart from the advantages, ABC has some disadvantages as well. Some of the disadvantages of
ABC method are: (Your Article Library, 2018)
(a) Costly – ABC method is a costly method, since its process is complicate. It involves the
identification of costs and their cost drivers, which makes the process costly. Hence, the
small business cannot adopted ABC. Further, if the overheads amount is small, then also
implementation of ABS is not useful and not recommended.
(b) Complicated / Specialized Knowledge– ABC is a complicated process since it has 3 to 4
steps. Further, the business implementing ABC needs to hire ABC professional for its
implementations, which increases its costs and even after implementation, the trained
professionals are required for proper running of ABC System. Hence, the specialized
knowledge is required for ABC.
(c) Not for single product – ABC method is not useful for companies producing single
product as there is no need to allocate the overheads and the entire overheads belong to
one product produced.

References:
1. Money Matters | All Management Articles. (2018). Advantages and Disadvantages of
Activity Based Costing. [online] Available at: https://accountlearning.com/advantages-
and-disadvantages-of-activity-based-costing/ [Accessed 9 May 2018].
2. Your Article Library. (2018). Advantages and Demerits of Activity Based Costing
(ABC). [online] Available at:
http://www.yourarticlelibrary.com/accounting/costing/advantages-and-demerits-of-
activity-based-costing-abc/52617 [Accessed 9 May 2018].