T217 Acc200 Introduction To Management Accounting Assignment

T217 Acc200 Introduction To Managementaccounting Assignment 20

Jackson Ltd manufactures two products, FRED and MARTHA, and uses a single plantwide overhead rate based on direct labour hours. The company is considering adopting Activity Based Costing (ABC) to improve product costing accuracy and competitive pricing. The assignment involves calculating costs per unit using both traditional and ABC approaches, analyzing the impact on pricing, and discussing the advantages and disadvantages of ABC.

Paper For Above instruction

Introduction

Accurate product costing is crucial for effective management and competitive pricing. Traditional volume-based costing methods allocate overhead proportionally to direct labor hours, which can distort costs when products consume overhead differently. Activity Based Costing (ABC) offers a refined approach, assigning costs based on actual activities driving overhead expenses. This paper examines Jackson Ltd's scenario involving two products, FRED and MARTHA, to compare traditional and ABC methods, analyze product costs and pricing, and explore the implications of adopting ABC.

Part (a): Conventional Costing Approach

Under the traditional approach, overhead costs are allocated using a predetermined overhead rate based on direct labor hours. The total estimated overhead is $816,000, with total direct labor hours calculated as follows: FRED requires 2 hours per unit and MARTHA requires 3 hours per unit. Production quantities are 1,000 units of FRED and 5,000 units of MARTHA.

Total direct labor hours for FRED = 1,000 units × 2 hours = 2,000 hours.

Total direct labor hours for MARTHA = 5,000 units × 3 hours = 15,000 hours.

Total labour hours = 2,000 + 15,000 = 17,000 hours.

Predetermined overhead rate = $816,000 / 17,000 hours ≈ $48 per hour.

Overhead cost per unit:

- FRED: 2 hours × $48 = $96.

- MARTHA: 3 hours × $48 = $144.

Total manufacturing cost per unit:

- FRED: Material ($40) + Labour ($30) + Overhead ($96) = $166.

- MARTHA: Material ($60) + Labour ($45) + Overhead ($144) = $249.

Part (b): Cost per Activity Pool Using ABC

To implement ABC, we allocate overhead to activities based on cost drivers, then assign these to products. The activity cost pools are: Machine-related costs, Setup and inspection, Engineering, and Plant-related costs.

Step 1: Calculate total activity costs

- Machine-related costs: $450,000

- Setup and inspection: $180,000

- Engineering: $90,000

- Plant-related costs: $96,000

Step 2: Determine cost driver rates

- Machine costs per hour: $450,000 / 9,000 hours = $50/hour

- Setup costs per production run: $180,000 / 40 runs = $4,500 per run

- Engineering costs per change order: $90,000 / 100 change orders = $900 per change order

- Plant costs per square foot: $96,000 / 1,920 sq ft = $50 per sq ft

Part (c): Product Cost per Unit Using ABC

Step 1: Allocate overhead to activities based on activities per product:

- Machine-related costs:

FRED: 1,000 units × 4 machine hours = 4,000 machine hours.

MARTHA: 5,000 units × 1 machine hour = 5,000 machine hours.

Total machine hours are within the budgeted 9,000 hours.

- Machine overhead allocated: $50 × total machine hours per product.

- Setup and inspection costs:

FRED: production in batches of 50 units, so number of runs = 1,000 / 50 = 20 runs.

MARTHA: batch size 250 units, number of runs = 5,000 / 250 = 20 runs.

Since setups are per run, total setup costs for each product are: 20 runs × $4,500 = $90,000.

- Engineering costs:

FRED: 25 change orders (75% of 100) relating to FRED's activities.

MARTHA: 75 change orders.

- FRED: 25 × $900 = $22,500

- MARTHA: 75 × $900 = $67,500

- Plant-related costs:

- Space used

FRED: 80% of total space = 1,536 sq ft

MARTHA: 384 sq ft

- Assign costs based on space

FRED: 1,536 × $50 = $76,800

MARTHA: 384 × $50 = $19,200

Step 2: Allocate activity costs to products per unit

- Machine-related costs per product:

FRED: (4,000 hours / 1,000 units) × $50 = $200 per unit

MARTHA: (5,000 hours / 5,000 units) × $50 = $50 per unit

- Setup and inspection costs per unit:

FRED: $90,000 / 1,000 units = $90 per unit

MARTHA: same as above, since same setup costs are distributed across units in their respective batches.

- Engineering costs per unit:

FRED: $22,500 / 1,000 units = $22.50

MARTHA: $67,500 / 5,000 units = $13.50

- Plant-related costs per unit:

FRED: $76,800 / 1,000 units = $76.80

MARTHA: $19,200 / 5,000 units = $3.84

Total ABC cost per unit:

- FRED: Material ($40) + Labour ($30) + Machine ($200) + Setup ($90) + Engineering ($22.50) + Plant ($76.80) ≈ $459.30

- MARTHA: Material ($60) + Labour ($45) + Machine ($50) + Setup ($90) + Engineering ($13.50) + Plant ($3.84) ≈ $262.34

Part (d): Pricing Based on ABC Costing (120% markup)

- FRED: $459.30 × 120% = $551.16

- MARTHA: $262.34 × 120% = $314.81

These are the selling prices per unit derived from ABC-based costs, incorporating the same markup approach as the conventional method.

Part (e): Impact of Using ABC on Product Pricing

The conventional volume-based approach assumes that overhead costs are driven solely by direct labor hours, leading to potential cost distortion. For instance, FRED’s overhead was understated (allocated as $96) per unit, while MARTHA's overhead was overstated ($144). Consequently, FRED was underpriced, risking margin erosion, whereas MARTHA was potentially overpriced. These inaccuracies can cause mispricing, affecting competitiveness and product profitability. ABC reveals that MARTHA consumes less overhead per unit than suggested by traditional methods, thus allowing more accurate pricing that reflects true resource consumption. This prevents over-or under- costing and ensures that prices align with actual costs, fostering better strategic decisions and competitive positioning.

Part (f): Benefits of Implementing ABC

Adopting ABC provides several advantages: the ability to identify high-cost activities and eliminate or modify inefficient processes; enhanced accuracy in product costing facilitates better pricing strategies; improved understanding of cost drivers supports strategic decision-making such as product prioritization and process improvements; facilitates cost control and profitability analysis at a more granular level; and aids in identifying opportunities for cost reduction and efficiency gains. By linking overhead costs more precisely to activities, ABC helps managers make informed decisions that improve overall financial performance.

Part (g): Disadvantages of Using ABC

Despite its benefits, ABC has certain drawbacks. Implementation can be costly and time-consuming, requiring significant data collection and analysis efforts. It may involve complex calculations and maintenance, which can increase administrative overhead. Furthermore, ABC may not be suitable for all types of organizations or products, especially where overhead costs are relatively low or stable. Additionally, resistance from employees accustomed to traditional methods can hinder adoption. Managers may also find ABC data too detailed or complex for routine decision-making, potentially leading to analysis paralysis.

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