Chapter 3.A, Problem 2E

To determine

Introduction:

Traditional Costing System: A cost accounting system records the production activities using a perpetual inventory system. Traditional costing allocates factory overhead to products based on the volume of production and resources utilised. Factory/manufacturing overheads are usually applied either based on machine hours or labour hours. The problem with the traditional costing system is that the factory overhead may be relatively higher than the basis of allocation where a small change in volume of production may result in a significant change in the absorption of overheads.

Activity Based Costing System: Activity based costing as a method of costing was introduced to overcome the limitations of traditional costing system. Allocation and absorption of factory overheads using common parameters such as labour/machine hours result in inconsistencies. A manufacturing process is divided into various batches and activities. Not all the batches or stages of production are uniform. Different batches require different amount of human efforts or machine hours. Hence, activity based costing aims in identifying activities or production processes for producing a product. The individual activities are combined together with similar processes to form a cost pool. The pool is then analysed and assigned at a predetermined overhead rate that will be assigned to individual jobs and products.

(1)

To compute:

Unit product costs using the traditional costing system.

To determine

(2)

To compute:

Unit product costs using the activity-based absorption costing system.

To determine

(3)

To ascertain:

Reason for differences in product costs between the two systems.