PART A: Bingley Products a). Solution: Comparing Volume based costing with ABC. (i)Departmental Apportionment of Overhead CostsProductMachining Dept(£)Assembly Dept (£)Widgets 120,000 288,750Gadgets 240,000 99,000 Helios144,000 49,500 Total504,000 437,250 The above calculations were arrived at by multiplying the number of machine hours per unit for each product by the number of units produced and then multiply by the cost per unit. For example the £120,000 for Machine department costs applied to widgets is calculated by taking 2machine hours per unit time 50,000 x 1.2. Mathematically we can write thus: Overhead cost for widgets allocated to machining department= Number of units produced x number of machine hours per unit x machining department machine hour rate= 50000 x 2 x £1.2 per machine hour = £120,000.Overhead cost for widgets allocated to assembly department = Number of units produced x number of labour hours per unit x assembly department’s labour hour rate = 50000 x 7 x £0.825 = £288,750.Widgets (£)Gadgets (£)Helios (£)Sales 2,250,000 3,800,000 2.190.000Cost of Sales: Direct costs: Direct labour and Materials 1,600,000 3,360,000 1,950,000 Factory Overhead Costs: Machining Department 120,000 240,000 144,000 Assembly Department288,750 99,000 49,500 Total costs2,008,750 3,699,000 2,143,500 Gross Margin241,250 101,000 46,500 Product Profitability Analysis Statement UnderTraditional Absorption CostingThe figure for sales is calculated by multiplying the number of units by the cost per unit.
For example sales for Widgets is calculated as follows: Number of Units produced and sold = 50000 unitsSales price per unit = £45Sales figure 50000 X £45 = £2,250,000Similar calculations have been done for Gadgets and Helios to arrive at the figures of £3,800,000 and £2,190,000 respectively. The direct labour and materials cost is calculated by multiplying the units produced by the direct labour and material cost per unit.
For example the amount for Widgets is calculated thus: Number of units produced= 50000 unitsDirect labour and material cost per unit = £ 32Total direct labour and material cost = 50000 x £ 32 = £1,600,000.Similar calculations have been done for Gadgets and Helios. Overhead Absorption based on Activity cost driversApportionment of overheads to cost pools Activity Consumption cost driver (1)Cost (2) £Activity Consumption (3)Activity rate(2)/(3) £Machine Hours357.0004200000.85Direct Labour Hours318.0005300000.6Set-ups26.00052050Customer Orders156.000320004.875Supplier Orders84.000112007.5 Here the activity rate for each cost driver is calculated by dividing the activity cost by the amount of consumption of the activity.
These rates are later used to calculate the costs to be allocated for each product as shown below. Apportionment of Overheads to ProductsWidgets (50000 Units)Activity Consumption cost driver (1)Activity rate (2) £Activities (3)Total Overhead (4)=(2)x(3) £Overhead per unit (5) £Set-ups501206,0000.12Customer Orders4.875800039,0000.78Supplier Orders7,5300022,5000.45Machining Department0.8510000085,0001.7Assembly Department0.6350000210,0004.2Overhead Cost per unit362,5007.25As can be seen above, the total overhead arising from each cost driver is calculated by multiplying the activity rate for that cost driver to the amount of activities demanded by the product.
The overhead cost per unit is calculated by dividing the total overhead cost for each cost driver by the number of units produced as we can see from the table above. For example, to calculate the overhead cost per unit for customer orders assigned to product (Widgets), we proceed as follows: Number of Units produced 50000Number of customer orders (activities)= 8000Activity rate= £4.875Total overhead = £4.875 x 8000 = £39,000Overhead per unit = £39,0000/50000 = £0.78Similar calculations have been done for Gadgets and Helios and for the other cost drivers. Gadgets (40000 Units)Activity Consumption cost driver (1)Activity rate (2) £Activities (3)Total Overhead (4)=(2)x(3) £Overhead per unit (5) £Set-ups5020010,0000,25Customer Orders4,875800039,0000,975Supplier Orders7,5400030,0000,75Machining Department0,85200000170,0004,25Assembly Department0,612000072,0001,8Overhead Cost per unit321,0008,025Helios (30000 Units) Activity consumption cost driver (1)Activity rate (2) £Activities (3)Total Overhead (4)=(2)x(3) £Overhead per unit (5) £Set-ups5020010,0000,33Customer Orders4,8751600078,0002,6Supplier Orders7,5420031,5001,05Machining Department0,85120000102,0003,4Assembly Department0,66000036,0001,2Overhead Cost per unit257,5008,58Product Profitability Analysis Statement Under Activity Based CostingWidgets (£)Gadgets (£)Helios (£)Sales 2,250,0003,800,0002,190,000Cost of Sales: Direct costsDirect labour and Materials1,600,0003,360,0001,950,000Overhead Costs: Set-up cost6,00010,00010,000Order processing cost39,00039,00078,000Purchasing cost22,50030,00031,500Machining Department85,000170,000102,000Assembly Department210,00072,00036,000Total costs1,962,5003,681,0002,207,500Gross Margin287,500119,000(17,500)(ii) Profitability analysis statements have been prepared using two costing methods, including the traditional absorption costing method and activity based costing method for three different products Widgets, Gadgets and Helios.
One of the most important differences we can observe is that the product Helios proves to be profitable under absorption costing whereas it returns a loss under activity based costing (ABC). Also, the products Widgets and Gadgets are more profitable under ABC than under absorption costing. Therefore we can conclude that under absorption costing, some of the costs, which ought to be allocated to Helios, were allocated to Widgets and Gadgets and thus the product proved that it was profitable.
The reason for this difference is that volume-based costing tends to under-cost low volume products at the expense of high volume products. (Blocher et al, 2005: pp 145). We can see that only 30000 units were produced for Helios while 50000 and 40000 units were produced and sold for Widgets and Gadgets respectively. This is consistent with the latter assertion that volume based costing system under-costs low volume products at the expense of high volume products. According to Bocher et al (2005), activity based costing differs from volume based costing in two ways: First under ABC cost pools are defined as activities or activity centers and not production plant or department centers.
Second the cost drivers used by ABC to assign costs to products are drivers based on an activity or activities performed for the product. The traditional costing method on its part uses an arbitrarily selected cost driver that often bears little or no relationship to the consumption of resource cost by the products to assign costs to the product.