Chapter C, Problem 4BPSB

To determine

Activity Based Costing:

Activity based costing is a unique and modern method of allocation of overheads among the products as compared to traditional and departmental base of overheads allocation (where single rate is used for plant or for each departments irrespective of type of cost incurred in the department).

In activity base costing, the cost pool is designed for each type of activity involved in the organization and cost incurred relating to that activity is accumulated in that cost pool. The driver that drives the happening of the activity is observed and is used to compute the overheads rate of using that activity.

The Overheads are allocated to the products on the basis of drivers it consumes for each type of activity. Thus, the activity based costing is a modern and more comprehensive method of allocation of overheads.

Requirement1:

To Determine: The Manufacturing cost and gross profit per unit using plant-wide Oh rate.

Answer to Problem 4BPSB

Solution: The manufacturing cost per unit for both the products is as under:

Standard: $88.20 per unit

Deluxe: $ 112.20 per unit

The Gross profit per unit for both the products is computed as under:

Standard: $ 3.80 per unit

Deluxe: $ 12.80 per unit

Explanation of Solution

For computing the manufacturing cost per unit, the plant-wide overheads rate per machine hour is computed by dividing the total manufacturing overheads by total machine hours used in production of products and is computed as under:

Computation of OH cost per case for both products:
Indirect Manufacturing cost:
Engineering Support			56250
Electricity			112500
Setup cost			41250
Total Overheads cost:				210000
Divide: Total Machine hours
Standard (40000 units @ 3MH)			120000
Deluxe (10000 units @ 3 MH)			30000
Total Machine hours				150000
Overheads rate per MH				1.4

The manufacturing cost per unit is computed by adding the material cost, labour cost and manufacturing overheads per unit of each product as under:

Computation of Total cost per unit for each product:
			Standard	Deluxe
Material per unit			4	8
Labour cost per unit @ 20 per DLH			80	100
Manufacturing Overheads @1.4 per MH			4.2	4.2
Total cost per unit			88.2	112.2

The Gross profit per unit is computed by deducting the manufacturing cost per unit computed above from the selling price per unit of each product as under:

Computation of Gross Margin per unit of each product:
			Standard	Deluxe
Market price per case			92	125
Less: Total cost per case			88.2	112.2
Gross Margin per unit			3.8	12.8

To determine

Requirement2:

To determine: The Gross margin per customer is to be computed for each product.

Answer to Problem 4BPSB

Solution: The gross margin per customer for each product is computed as under:

Standard: $ 27.00 per customer

Deluxe: $ 3.00 per customer.

The customer service cost per customer for each product is computed as $ 125 per customer.

From this comparison, it has been observed although the gross margin per unit of Deluxe product is higher but its gross margin per customer is lower due to low turnover of product.

Explanation of Solution

The customer service cost per customer is computed by dividing the customer service cost by total number of customers as under:

Computation of Customer Service cost per customer
Total Customer service cost			250000
Divide: Total Number of customers			2000
(1000+1000)
Customer service cost per customer			125

The Gross margin per customer is computed by computing the total margin earned for each product based on number of units and gross margin per unit as computed above. The total margin thus computed is divided by number of customers and then customer service cost per customer is deducted to arrive at the gross margin per customer as under:

Computation of Gross margin per customer
			Standard	Deluxe
			40000 units	10000 units
Gross Margin
Standard (40000 units @3.8)			152000
Deluxe (10000 units @ 12.8)				128000
Divide: Number of customer			1000	1000
Margin per customer			152	128
Deduct: Customer service cost per customer			125	125
Gross Margin per customer			27	3

To determine

Requirement3:

To determine: The computation of total manufacturing cost and gross margin per unit of each product under Activity based costing.

Answer to Problem 4BPSB

Solution: The Total manufacturing cost per unit of each product is computed as under:

Standard: $ 87.91 per unit

Deluxe: $ 113.36 per unit

The gross profit per unit for each product is computed as under:

Standard: $ 4.09 per unit

Deluxe: $ 11.64 per unit

Explanation of Solution

Under activity based costing, the activity rates of each activity cost pool is firstly determined by dividing the activity cost by drivers as under:

STATEMENT SHOWING ACTIVITY RATE OF ACTIVITY POOL
		Activity	Total	Expected	Activity
ACTIVITY COST POOL		Measures	Overheads	Activity	Rate
Indirect manufacturing:
Engineering Support		Modification	56250	75	750	per modification
Electricity		MH	112500	150000	0.75	per MH
Setup cost		Batches	41250	250	165	per Batch

Afterward the activity rate, the activity cost shall be allocated to each product based on activity drivers consumed for the production of it and activity cost per case is computed by dividing the total activity cost by number of cases produced as under:

Computation of Total OH cost per unit for each product:
Activity		Activity	Standard		Deluxe
		rate	Activity	OH cost	Activity	Oh cost
Indirect manufacturing:
Engineering Support		750	50	37500	25	18750
Electricity		0.75	120000	90000	30000	22500
Setup cost		165	175	28875	75	12375
Total Overheads				156375		53625
Divide: Number of units				40000		10000
Oh cost per unit				3.91		5.36

As a last step for total cost, the material and labour cost per case is added to the overheads cost per case to arrive at the total cost per case as under:

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Computation of Total cost per unit for each product:
			Standard	Deluxe
Material per unit			4	8
Labour cost per unit @ 20 per DLH			80	100
Manufacturing Overheads @1.4 per MH			3.91	5.36
Total cost per unit			87.91	113.36

The gross profit per unit is computed by deducting the manufacturing cost per unit from selling price per unit of each product as under:

Computation of Gross Margin per unit of each product:
			Standard	Deluxe
Market price per case			92	125
Less: Total cost per case			87.91	113.36
Gross Margin per unit			4.09	11.64

To determine

Requirement4:

To determine: The Gross margin per customer is to be computed for each product.

Answer to Problem 4BPSB

Solution: The gross margin per customer for each product is computed as under:

Standard: $ 38.60 per customer

Deluxe: ($ 8.60) per customer.

The gross margin per customer for Deluxe product is not adequate.

Explanation of Solution

The customer service cost per customer is computed by dividing the customer service cost by total number of customers as under:

Computation of Customer Service cost per customer
Total Customer service cost			250000
Divide: Total Number of customers			2000
(1000+1000)
Customer service cost per customer			125

The Gross margin per customer is computed by computing the total margin earned for each product based on number of units and gross margin per unit as computed above. The total margin thus computed is divided by number of customers and then customer service cost per customer is deducted to arrive at the gross margin per customer as under:

Computation of Gross margin per customer
			Standard	Deluxe
			40000 units	10000 units
Gross Margin
Standard (40000 units @4.09)			163600
Deluxe (10000 units @ 11.64)				116400
Divide: Number of customer			1000	1000
Margin per customer			163.6	116.4
Deduct: Customer service cost per customer			125	125
Gross Margin per customer			38.6	-8.6

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To determine

Requirement5:

To determine: The Observation regarding method for allocation of overheads cost among products.

Answer to Problem 4BPSB

Solution: The Activity based costing method is the best method for allocating the overheads among the products on the basis of cost drivers consumed for each respective activity rather than one allocation base being used for allocating cost of various nature under plant-wide overhead rate.

Explanation of Solution

The Activity based costing determines the cost drivers for each activity cost rather than a single drivers being used for all the activities cost as that might not be a suitable base for allocating the overheads.

Thus, allocation of overheads on the basis of activity based costing is the best measure of overheads and pricing based on this measures is most reliable.

Conclusion

To conclude, it can be said that activity based costing is the best way of allocation of overheads among the products.

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