COST ACCOUNTING(CONVERTING TO ABC COSTING)

Cost Accounting- Traditional vs . ABC

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Date The allocation of manufacturing overheads has been normally done using traditional costing method where the costs were allocated based on the direct labor hours . This leads to wrong cost determination that consequently results in inaccurate product cost and prices as well . The emergence of activity based costing avoided the problems associated with traditional costing methods

ABC assigns overheads to activities that actually lead to the incurrence of the costs

Awnings manufacturing

The manufacture

of awnings involves the following stages : the fabric is firstly cotton made according to the specifications of the The fabric is then de signed and engineered to fit the shape and size requested by the customer . The next process involves the designing of the poles and its holders according to the shape of the desired awning The last step involves the packaging of the awning

The costs to be incurred in the manufacturing process include direct material , direct labor , machine set up costs , engineering , packaging cost and machine hour costs

Consider the following data for the above company

Item Sales (unit ) 5 5

Direct materials ) 100 500

Direct labor hours 50 250

Machine hours 20 150

Direct labor cost ) 10 2500

Number of production runs 5 5

Number of deliveries 5 5

Number of s 5 5 Overheads Amounts

Set up 500

Packaging 50

Machines 1000

Engineering 1200 Traditional costing method

As seen earlier seen , the tradition method allocates the overheads based on a single activity e .g . the number of direct labor hours consumed in the manufacturing process

The product unit cost will then be calculated as follows

Overhead absorption rate br 250 11 per direct labor

The overhead absorption rate is then multiplied with the per indirect labor costs

The per unit direct labor costs 2500 100

Therefore the Unit costs

Direct materials 100

Direct labor 10

Overheads 1100 1210

Activity Based Costing

Activities

The activities involved are custom engineering and designing , machine set up and packaging

Cost pools

The cost pools will then be set up , machines , packaging and engineering

Workings

The activities and allocation of costs to cost pools has been done above

The activity rates are determined as follows

Rate overhead amount

Number of activity

Set up rate 500 100 per set up

Packaging rate 50 10 per package

Machines hour rate 1000 6 .67 per machine hour

Engineering 1200 240 per

The various overhead costs are calculated as follows Overhead x number of activities

For set up costs

Set up costs 100x5 500

Therefore set up cost per unit 500

5 units 100

Packaging rate

Packaging costs 10x5 50

Packaging cost per unit 50

5 unites 10

Machine costs 6 .67 x 150 1000

Machine cost per unit 1000

5 units 100

Engineering costs

Costs 240 x5 1200

Engineering cost per unit 1200

5 units 240

Therefore , the product unit cost is arrived at by adding the individual direct costs as well as the indirect costs (overheads

Unit costs...