KAM Limited manufactures two type of machine: Agro and Farm. The weekly production is 1,500 units of Agro and 1,000 units of Farm. The products are made in batches, before a batch can be made the production machinery must be set-up, checked for accuracy. Each batch produced has quality inspection to ensure that it is of the required standard. The following are the details of each product: Agro Farm Units produced in one batch 500 units 250 units Selling price per unit £200 £160 Direct materials per unit £60 £40 Direct labour per unit (one hour per unit) £20 £20 The following are the fixed production costs each week: Set-up costs of machinery £28,000 Quality inspection costs of production £14,000 Currently the company uses absorption costing. Fixed production costs are attributed to output on the basis of direct labour hours. The management is considering activity-based costing approach. You are required to: Calculate the overheads attributed to Agro and Farm each week through absorption (full) costing, on the basis of direct labour hours. Show your calculation process. Calculate the overheads attributed to Agro and Farm each week through Activity-based Costing with the cost divers of set-up and quality inspection. Show your calculation process. Prepare brief income statements to show how absorption costing and activity-based costing will deal differently with the costs. Advise the management of KAM Limited which is the more appropriate method of charging overheads to output.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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KAM Limited manufactures two type of machine: Agro and Farm. The weekly production is 1,500 units of Agro and 1,000 units of Farm.

The products are made in batches, before a batch can be made the production machinery must be set-up, checked for accuracy. Each batch produced has quality inspection to ensure that it is of the required standard.

The following are the details of each product:

	Agro	Farm
Units produced in one batch	500 units	250 units
Selling price per unit	£200	£160
Direct materials per unit	£60	£40
Direct labour per unit (one hour per unit)	£20	£20

The following are the fixed production costs each week:

Set-up costs of machinery	£28,000
Quality inspection costs of production	£14,000

Currently the company uses absorption costing. Fixed production costs are attributed to output on the basis of direct labour hours.

The management is considering activity-based costing approach.

You are required to:

Calculate the overheads attributed to Agro and Farm each week through absorption (full) costing, on the basis of direct labour hours. Show your calculation process.
Calculate the overheads attributed to Agro and Farm each week through Activity-based Costing with the cost divers of set-up and quality inspection. Show your calculation process.
Prepare brief income statements to show how absorption costing and activity-based costing will deal differently with the costs.
Advise the management of KAM Limited which is the more appropriate method of charging overheads to output.

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