Lesson 3 - ABC Question Set, accounting

7/21/2019 Lesson 3 - ABC Question Set, accounting

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Lesson 3: Activity Based Costing

ABC problems are kind of mechanical and tedious, but that really is the nature of these topics. We wantto drill the concept of costs into you so that it will come out naturally. Enjoy!

Warm-Up

1)

What are the fundamental differences between a traditional and an ABC system?

2) Describe the circumstances when traditional costing systems are likely to report distorted costs.

3) Explain how low volume products can be undercosted and high volume products overcosted whentraditional costing systems are used.

4) Having attended a CIMA course on activity-based costing (ABC) you decide to experiment byapplying the principles of ABC to the four products currently made and sold by your company.Details of the four products and relevant information are given below for one period:

The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate,and the total of the production overhead for the period has been analyzed as follows:

You have ascertained that the ‘cost drivers’ to be used are as listed below for the overhead costsshown

The number of requisitions raised on the stores was 20 for each product and the number of ordersexecuted was 42, each order being for a batch of 10 of a product.

Product A B C D

Output in units 120 100 80 120

Costs per unit: (£) (£) (£) (£)

Direct material 40 50 30 60

Direct labour 28 21 14 21

Machine hours (per unit) 4 3 2 3

(£)

Machine department costs (rent, businessrates, depreciation and supervision) 10430

Set-up costs 5 250

Stores receiving 3 600

Inspection/Quality control 2 100

Materials handling and dispatch 4 620

Cost Cost driver

Set up costs Number of production runsStores receiving Requisitions raised

Inspection/Quality control Number of production runs

Materials handling and despatch Orders executed



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You are required to:

a) to calculate the total costs for each product if all overhead costs are absorbed on a machinehour basis(b) to calculate the total costs for each product, using activity-based costing;(c) to calculate and list the unit product costs from your figures in (a) and (b) above, to show thedifferences and to comment briefly on any conclusions which may be drawn which could havepricing and profit implications.

5) W is a manufacturing company that produces three products: X, Y and Z. Each uses the sameresources, but in different quantities as shown in the table of budgeted data for 2010 below:

W’s budgeted production overhead costs for 2010 are $400 000 and current practice is to absorbthese costs into product costs using an absorption rate based on direct labour hours. As a resultthe production overhead cost attributed to each product unit is:

Product X $32 Product Y $64 Product Z $48

The management of S are considering changing to an activity based method of attributingoverhead costs to products and as a result have identified the following cost drivers and relatedcost pools:

The remaining $80 000 of overhead costs are caused by a number of different factors andactivities that are mainly labour related and are to be attributed to products on the basis of labourhours.

Required:(a) Calculate the production overhead cost attributed to each product unit using an activity-basedapproach.(b) Explain how W has applied Pareto Analysis when determining its cost drivers and how it maycontinue to use Pareto Analysis to control its production costs

Product X V Z

Budgeted production 1500 2500 4000

Direct labour hours per unit 2 4 3

Machine hours per unit 3 2 3

Batch size 50 100 500

Machine setups per batch 2 3 1Purchase orders per batch 4 4 6

Material movements per batch 10 5 4

Cost pool $ Cost driver

Machine maintenance 100 000 machine hours

Machine setups 70 000 machine setups

Purchasing 90 000 purchase orders

Material handling 60 0 00 material movements



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6)

XY provides accountancy services and has three different categories of client: limited companies,self employed individuals, and employed individuals requiring taxation advice. XY currentlycharges its clients a fee by adding a 20% mark-up to total costs. Currently the costs are attributedto each client based on the hours spent on preparing accounts and providing advice.

XY is considering changing to an activity based costing system. The annual costs and the causes ofthese costs have been analyzed as follows:

The following details relate to three of XY’s clients and to XY as a whole:

Required:Prepare calculations to show the effect on fees charged to each of these three clients of changingto the new costing system.

7)

Abkaber plc assembles three types of motorcycle at the same factory: the 50cc Sunshine; the250cc Roadster and the 1000cc Fireball. It sells the motorcycles throughout the world. In

response to market pressures Abkaber plc has invested heavily in new manufacturing technologyin recent years and, as a result, has significantly reduced the size of its workforce.

Historically, the company has allocated all overhead costs using total direct labour hours, but isnow considering introducing activity-based costing (ABC). Abkaber plc’s accountant hasproduced the following analysis.

$

Accounts preparation and advice 580 000

Requesting missing information 30 000

Issuing fee payment reminders 15 000

Holding client meetings 60 000

Travelling to clients 40 000

en

A B C XY

Hours spent on preparing

accounts and providing advice 1 0 00 250 340 18 0 00

Requests for missing information 4 10 6 250

Payment reminders sent 2 8 10 400

Client meetings held 4 1 2 250

Miles travelled to meet clients 150 600 0 10 000

Annual

Output

(units)

Annual

Direct

Labour

Hours

Selling

Price

(£ per unit)

Raw

material

cost

(£ per unit)

Sunshine 2000 200 000 4000 400

Roadster 1600 220 000 6000 600

Fireball 400 80 000 8000 900



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All direct labour is paid at £5 per hour. The company holds no stocks. At a board meeting there was some concern over the introduction of activity-based costing.

The finance director argued: ‘I very much doubt whether selling the Fireball is viable but I am notconvinced that activity-based costing would tell us any more than the use of labour hours in

assessing the viability of each product.’

The marketing director argued: ‘I am in the process of negotiating a major new contract with amotorcycle rental company for the Sunshine model. For such a big order they will not pay ournormal prices but we need to at least cover our incremental costs. I am not convinced thatactivity-based costing would achieve this as it merely averages costs for our entire production.’

The managing director argued: ‘I believe that activity-based costing would be an improvement butit still has its problems. For instance, if we carry out an activity many times surely we get better atit, and costs fall rather than remain constant. Similarly, some costs are fixed and do not varyeither with labour hours or any other cost driver.’

The chairman argued: ‘I cannot see the problem. The overall profit for the company is the same

no matter which method of allocating overheads we use. It seems to make no difference to me.’

Required:

(a) Calculate the total profit on each of Abkaber plc’s three types of product using each of thefollowing methods to attribute overheads:

(i) the existing method based upon labour hours; and(ii) activity-based costing

(b) Write a report to the directors of Abkaber plc, as its management accountant. The reportshould:

The three cost drivers that generate overheads are:

Deliveries to retailers – the number of deliveries of motorcycles to

retail showrooms

Set-ups – the number of times the assembly line

process is re-set to accommodate a

production run of a different type of

motorcycle

Purchase orders – the number of purchase orders.

The annual cost driver volumes relating to each activity and for each

type of motorcycle are as follows:

Number of

deliveries

to retailers

Number of

set-ups

Number of

purchase

orders

Sunshine 100 35 400

Roadster 80 40 300

Fireball 70 25 100

The annual overhead costs relating to these activities are as follows:

£

Deliveries to retailers 2 400 000

Set-up costs 6 000 000

Purchase orders 3 600 000



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(i) evaluate the labour hours and the activity-based costing methods in the circumstancesof Abkaber plc; and(ii) examine the implications of activity-based costing for Abkaber plc, and in so doingevaluate the issues raised by each of the directors.

Refer to your calculations in requirement (a) above where appropriate.

8)

A healthcare company specialises in hip, knee and shoulder replacement operations, known assurgical procedures. As well as providing these surgical procedures the company offers preoperation and post operation in-patient care, in a fully equipped hospital, for those patients who

will be undergoing the surgical procedures.

Surgeons are paid a fixed fee for each surgical procedure they perform and an additional amountfor any follow-up consultations. Post procedure follow-up consultations are only undertaken ifthere are any complications in relation to the surgical procedure. There is no additional feecharged to patients for any follow up consultations. All other staff are paid annual salaries.

The company’s existing costing system uses a single overhead rate, based on revenue, to chargethe costs of support activities to the procedures. Concern has been raised about the inaccuracy ofprocedure costs and the company’s accountant has initiated a project to implement an activity-

based costing (ABC) system.

The project team has collected the following data on each of the procedures.

The project team has obtained the following information about the support activities.

Procedure information Hip Knee Shoulder

Fee charged to patients

per procedure $8000 $10 000 $6000

Number of procedures

per annum 600 800 400

Average time per procedure 2.0 hours 1.2 hours 1.5 hours

Number of procedures

per theatre session 2 1 4

In-patient days per procedure 3 2 1Surgeon’s fee per procedure $1200 $1800 $1500

% of procedures with

complications 8% 5% 10%

Surgeon’s fee per follow

up consultation $300 $300 $300

Cost of medical supplies

per procedure $400 $200 $300

Activity Cost driver

Overheads

$000

Theatre preparation for

each session

Number of theatre

preparations 864

Operating theatre usage Procedure time 1449

Nursing and ancillary

services

In-patient

days 5428

Administration Sales revenue 1216

Other overheads Number of procedures 923



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Required:

(a)

Calculate the profit per procedure for each of the three procedures, using the current basis forcharging the costs of support activities to procedures.

(b) Calculate the profit per procedure for each of the three procedures using activity-based costing(c) Discuss the ways in which the information obtained by the project team may be of benefit tothe management of the company

9) Trimake Limited makes three main products, using broadly the same production methods andequipment for each. A conventional product costing system is used at present, although anactivity-based costing (ABC) system is being considered. Details of the three products for a typicalperiod are:

Direct labour costs £14 per hour and production overheads are absorbed on a machine hour basis.The rate for the period is £28 per machine hour.

a) You are required to calculate the cost per unit for each product using conventional methods.

Further analysis shows that the total of production overheads can be divided as follows:

The following activity volumes are associated with the product line for the period as a whole. Totalactivities for the period:

b) calculate the cost per unit for each product using ABC principles;(c) to comment on the reasons for any differences in the costs in your answers to (a) and (b).

Hours per unit

Labour

hours

Machine

unit

Materials

per unit

£

Volumes

Units

Product X ½ 1½ 20 750

Product Y 1½ 1 12 1250

Product Z 1 3 25 7000

(%)

Costs relating to set-ups 35

Costs relating to machinery 20

Costs relating to materials handling 15Costs relating to inspection 30

Total production overhead 100%

Number

of set-ups

Number of

movements of

materials

Number of

inspections

Product X 75 12 150

Product Y 115 21 180

Product Z 480 87 670

670 120 1000



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10)

A company sells and services photocopying machines. Its sales department sells the machines andconsumables, including ink and paper, and its service department provides an after sales serviceto its customers. The after sales service includes planned maintenance of the machine and repairsin the event of a machine breakdown. Service department customers are charged an amount percopy that differs depending on the size of the machine.

The company’s existing costing system uses a single overhead rate, based on total sales revenuefrom copy charges, to charge the cost of the Service Department’s support activities to each size ofmachine. The Service Manager has suggested that the copy charge should more accurately reflectthe costs involved. The company’s accountant has decided to implement an activity-based costingsystem and has obtained the following information about the support activities of the servicedepartment:

The following data have also been collected for each machine size:

Each customer has a service contract for two machines on average:

A)

Calculate the annual profit per machine for each of the three sizes of machine, using thecurrent basis for charging the costs of support activities to machines.

B)

Calculate the annual profit per machine for each of the three sizes of machine using activity- based costing.

Activity Cost driver

ver ea s

per annum

$000

Customer account

handling

Number of customers 126

Planned maintenance

scheduling

Number of planned

maintenance visits 480

Unplanned maintenancescheduling

Number of unplannedmaintenance visits 147

Spare part procurement Number of purchase

orders 243

Other overheads Number of machines 600

Total overheads 1596

Small

photocopiers

Medium

photocopiers

Large

photocopiers

Charge per copy $0.03 $0.04 $0.05

Average number of

copies per year per machine 60 000 120 000 180 000

Number of machines 300 800 500

Planned maintenance

visits per machine

per year 4 6 12

Unplanned maintenance

visits per machine

per year 1 1 2

Total number of

purchase orders

per year 500 1200 1000

Cost of parts per

maintenance visit $100 $300 $400

Labour cost per maintenance visit $60 $80 $100



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Answer Key:

1)

The main difference between a traditional based costing and an ABC system is that an ABC tendsto have more detailed cost drivers, and allocates costs based on specific activities as opposed to

just a singular overhead rate.

2) Traditional costing is likely to report distorted costs when there is a significant amount ofdifferent products and overhead comprises a large amount of costs. It is especially distorted whendirect labor or direct machine hours are used but some products are more complicated than theother products.

3) Some costs are incurred on a batch level as opposed to a unit level basis, and high volumeproducts tend to have a larger batch size. For example, a high volume product would have a batchsize of 100 and a low volume product would have a batch size of 10. If you allocate them on a unit

basis instead of a batch basis, you will overcost the high volume for things such as machinesetups, orders, or inspections.

4) a) Step 1: Obtain total overhead costs:

Total overhead costs = 10,430 + 5,250 +3,600 +2,100 + 4,620 = 26,000

Step 2: Total Machine Hours120 x 4 + 100 x 3 + 80 x 2 + 120 x 3= 480 + 300 + 160 + 360= 1,300

Step 3: Get overhead rate= 26,000 / 1,300= $20 / hour

Step 4 : Allocate!

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b)

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c) The costing for product C is significant different. Why? The number of requisitions raised isthe same regardless of volume. Because C is a low volume product, this cost is allocated to lessunits.

5)

Every problem beyond this point is a bit repetitive, but practice makes perfect.!

I actually recommend converting everything to a per product basis (total indirect cost per product)instead of on a per batch / per unit basis. As I discussed, this can hlep serve as your double-checking

mechanism for errors. Remember to convert everything and be aware if it is stated in per units or per batch. So get the number of batches first.

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Main difference between this and traditional costing is product X and Z. Because Product Z’s batch size isso much bigger, it has a tendency to incur less costs since it uses less batches (8) as opposed to X (30).

Pareto will be explained in POM105.

6)

Similar ABC problem but applied to a service company, which is kinda cool. In order to show the

effect of a change in system (20% of total costs), we need to compute both traditional and ABC.Certainly, the “total cost” will change based on the system, and so will the selling price.

First, compute traditional-based costing. If we need to use only one cost driver (hours preparingaccount services), then we need to allocate the TOTAL costs to this single driver.

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725,000 / 18,000 = $40.28 per hour spent on preparing account services

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7)

Key thing: Don’t forget the DLH Cost. It’s hidden within the paragraphs at $5 per hour, and thetable is stated in TOTAL DLH annually for all units produced, while selling price and rawmaterials is per unit. It is asking for total profit so you need to solve for total costs.

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b) The finance director is right that the more complicated fireball is selling at a loss, and ABC does show itto him (contrary to his hesitation regarding ABC). This shows the flexibility of ABC system for complexproducts. It does not average the costs of the entire production, contrary to the marketing director’sstance. Some OH can still be variable and this is where ABC becomes important.



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8) This is ABC applied to a healthcare system. We are running out of examples to use at this point haha!

What is unusual about this problem is that REVENUE is the cost driver ($ sales).

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ABC is useful for finding out which part of the procedure is inefficient (costs too much), after whichoperations can be revamped. For a hospital, it’s not feasible to simply drop a procedure offering because it

does not make any money.

9)

a)

L#Y'"

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b)

The first step is to get the total overhead cost, which is not directly given to you. However, ittold you that the rate per hour is $28 / hour and you can solve for the total machine hours.

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@1'C)23 ] , ,F-8. ,F-8.

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C<A<7B3,375 x 28 = $654,500 Overhead



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Distribute the overhead:

W $'63

O+3)N6 98W --EF.H8

452=0>+1U -.W ,9.FE..

453+105(6?5>C(0>R ,8W E/F,H8

D>6N+230'> 9.W ,E:F98.

5B9AB;;

W $'63 %10Q+1

B'35(

"230Q03U

K53+ @+1

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O+3)N6 98W --EF.H8 I)*<+1 'J O+3)N6 :H. 97,GE.

452=0>+1U -.W ,9.FE.. 452=0>+ ?')16 -9F9H8 8G:.

453+105(6

?5>C(0>R ,8W E/F,H8

453+105(

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D>6N+230'> 9.W ,E:F98.

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5B9AB;;

On a total basis:

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O+3)N6 H8 ,,8 7/.

452=0>+ ?')16 ,F,-8 ,F-8. -,F...

453+105(6 ?5>C(0>R ,- -, /H

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O+3)N $'63 -8F:7-GH- 9EF9,/G/7 ,:7F,,9G79

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453+105(6 $'63 EF/,HG8. ,HF,/.G:9 H,F,H:G//

D>6N+230'> $'63 -EF78-G8. 98F979G.. ,9,F887G8.

B'35( MQ+1=+5C $'63 H,F-,-GH- E/F/7-G7H 7/7F777G/,

I)*<+1 'J A>036 H8. ,F-8. HF...

M? N+1 A>03 E7GE8 HEG.H :EG-,

%01+23 ;5<'1 H -, ,7

%01+23 453+105(6 -. ,- -8!'&#) +',& ./" 0(%& 8C8:DB 88C:;7 8;6:C8

The key difference is because product Z was slightly overcharged. Multiplied by the large amount of units,the difference is enhanced. The overcharging was because product Z uses a disproportionate amount ofmachine hours, even though some costs are not machine driven.



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10)

You have to multiply the charge by the average number of copies per machine and multiply it bythe number of machines (multiply it twice!). Remember to understand the problem.

One more important thing: When it is asking you for the total profit, it is one thing to compute forthe indirect cost allocation, but another to find the other direct costs. Remember to compute forthe labor and part costs (direct labor and direct material also!)

Direct Cost Computation:

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@(5>>+C 450>3+>5>2+ N+1 452=0>+ 7 : ,-

A>N(5>>+C 450>3+>5>2+ N+1 452=0>+ , , -

B'35( &06036 8 H ,7

@513 $'63 N+1 &0603 ,.. 9.. 7..

;5<'1 $'63 N+1 &0603 :. /. ,..

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JX#)) P/$%KX L#"-/

$=51R+ @+1 $'NU .G.9 .G.7 .G.8

"Q+G I)*<+1 'J $'N0+6 N+1 452=0>+ :.F... ,-.F... ,/.F...

I)*<+1 'J 452=0>+6 9.. /.. 8..

!'&#) H/>/(K/ B9;A;;; <A69;A;;; 9AB;;A;;; 6A66;A;;;

Overhead cost / revenue = 1,596,000 / 8,880,000 = 0.18

O*5(( 4+C0)* ;51R+

B'35( K+Q+>)+ N+1 452=0>+ ,F/.. 7F/.. EF...

@513 $'63 N+1 452=0>+ 8.. -F,.. 8F:..

;5<'1 $'63 N+1 452=0>+ 9.. 8:. ,F7..

M? $'63 N+1 452=0>+ 9-7 /:7 ,F:-.

!'&#) ."'U%& V/" P#4R%(/ 575 8AC75 <6;

Some of the given in the problem are already in total (like purchase orders) some are on a per machine basis.

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$=51R+ @+1 $'NU .G.9 .G.7 .G.8

"Q+G I)* 'J $'N0+6 N+1 452=0>+ :.F... ,-.F... ,/.F...

I)*<+1 'J 452=0>+6 9.. /.. 8..

@(5>>+C 450>3+>5>2+ N+1 452=0>+ 7 : ,-

A>N(5>>+C 450>3+>5>2+ N+1 452=0>+ , , -

B'35( @)12=56+ M1C+16 @+1 ]+51 8.. ,F-.. ,F...

$'63 'J @5136 N+1 450>3+>5>2+ &0603 ,.. 9.. 7..

;5<'1 $'63 @+1 450>3+>5>2+ :. /. ,..



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B'35( A>N(5>>+C 450>3+>5>2+ 9.. /.. ,F... CA8;;

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N>/"R/#$ ./"

=((KX 3"%>/"

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I)*<+1 'J A>N(5>>+C 450>3+>5>2+

Q00636 -F,.. H.G..

ON51+ @513 @1'2)1+*+>3 -79F... I)*<+1 'J @)12=56+ M1C+16 -FH.. E.G..

M3=+1 MQ+1=+5C6 :..F... I)*<+1 'J 452=0>+6 ,F:.. 9H8G..

JX#)) P/$%KX L#"-/

$)63'*+1 "22')>3 ?5>C(0>R -9F:-8 :9F... 9EF9H8

@(5>>+C 450>3+>5>2+ O2=+C)(0>R 7/F... ,E-F... -7.F...

A>N(5>>+C 450>3+>5>2+ O2=+C)(0>R -,F... 8:F... H.F...

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I)*<+1 'J 452=0>+6 9.. /.. 8..

MQ+1=+5C _ 452=0>+ /99GH8 /E/GH8 ,-89GH8

@513 $'63 N+1 452=0>+ 8.. -F,.. 8F:..

;5<'1 $'63 N+1 452=0>+ 9.. 8:. ,F7..

!'&#) +',& ,F:97 9F88E /F-87

B'35( K+Q+>)+ N+1 452=0>+ ,F/.. 7F/.. EF...

!'&#) ."'U%& V/" P#4R%(/ 855 8AC98 795

Lesson 3 - ABC Question Set, accounting

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Transcript of Lesson 3 - ABC Question Set, accounting