Calculation Of Cost Per Unit Using Conventional Approach And ABC Method

Calculation of cost per unit using conventional approach

Calculation of cost per unit using conventional approach

FRED: $166

MARTHA: $249

Table 1: Table presenting calculation of cost per unit and total labour hours

Particular Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	FRED	MARTHA
	(Amount in $)	(Amount in $)
Direct Material	40	60
Direct Labour	30	45
Manufacturing Overhead	96	144
Total cost per unit	166	249
Direct labour hour for one product	2 hrs	3 hrs
Total hours	100*2	500*3
	2000	15000

 Calculation of Manufacturing Overhead Rate

Table 2: Table representing manufacturing overhead rate as per conventional method

Particular	Amount in $
Total Hours	2000+15000
	17000
Total Manufacturing Overhead	816000
Rate	816000/17000
	48

Machine related cost	450000	50
Set up and Inspection	180000	4500
Engineering	90000	900
Plant related cost	96000	50

Calculation of cost per activity for each activity cost pool

Table 3: Table representing allocation of cost as per ABC method

Activity Cost	Cost Driver	Total Units for Cost Driver	Total Cost (Amount in $)	Unit cost per cost driver
Machine-related cost	Machine Hours	9000 hours	450000	50
Set up and Inspection	No. of production runs	40 runs	180000	4500
Engineering	Engineering change order	100 change order	90000	900
Plant-related cost	Square footage of space	1920 sq. feet	96000	50
Total Manufacturing cost			816000

 
Activity Cost per product

Table 4: Allocation of cost to in accordance with cost driver

			Expected Use	Cost Assigned
Activity	Cost Driver	Unit Cost	FRED	MARTHA	FRED	MARTHA	Total Cost
Machine related cost	Machine Hours	50	7200	1800	360000	90000	450000
Set up and Inspection	No. of production runs	4500	20	20	90000	90000	180000
Engineering	Engineering change order	900	75	25	67500	22500	90000
Plant related cost	Square footage of space	50	1536	384	76800	19200	96000
Total					594300	221700	816000

FRED: $664.3 MARTHA: $150.42 Calculation of per unit overhead cost under ABC
Per unit overhead cost for FRED	(Amount in $)
Overhead cost assigned to Fred / No. of total units
594300/1000
594.3
Per unit overhead cost for Martha	(Amount in $)
Overhead cost assigned to Martha/ No. of total units
227100/5000
45.42

Calculation of product cost per unit on the basis of FRED and MARTHAs using Activity Based Costing

Table 5: Calculation of total cost as per ABC method

Particular	FRED	MARTHA
	(Amount in $)	(Amount in $)
Direct Material	40	60
Direct Labour	30	45
Manufacturing Overhead	594.3	45.42
Total cost per unit	664.3	150.42

Selling price per product

FRED: $797.16

MARTHA: $180.50

Calculation of  price that would be charged for FRED and MARTHA

Table 6: Calculation of selling price after allocating overhead as per ABC method

Particular	FRED	MARTHA
	(Amount in $)	(Amount in $)
Total cost per unit	664.3	150.42
Price Charged	120% above total cost per unit	120% above total cost per unit
Manufacturing Overhead	797.16	180.504
Selling price per unit	797.16	180.504

Comparison of Total Cost

Particular	FRED	MARTHA
Cost as per Conventional Method	166	249
Cost as per ABC Method	664.3	150.42

Comparison of Selling Price

Particular	FRED	MARTHA
Charging price as per Conventional Method  (Note)	199.2	298.2
Charging price  as per ABC Method	797.16	180.50

Note:

Calculation of selling price as per conventional method:

FRED:

Total cost +20%

166+ (166*.20)

$199.2

MARTHA

Total cost +20%

249+ (249*.20)

=$298.8

From above comparison, it can be analyzed that a major cost was apportioned to product FRED, but the same was not apportioned to it. Due to same reason the appropriate cost of the product was not ascertainable; as it was allocated on the traditional method. As per traditional method of allotting business expenses, mostly management expenditure costs are allocated in terms of such factors which are machine and labour working hours. Expressing it, in other words, traditional is involved of there is a sole driver of the overheads of the factory, that is machine and labour working hours or any other volume been produced an indicator. In fact, there is the existence of many drivers of the factory outlay; setup of machinery, exceptional inspections, handling, special warehousing and so on. Diversified portfolio or high demands, the higher there will be cost allocation if these different activities through just one activity, like the machine hours of productivity (Stapleton et al., 2004).

According to the traditional method, performing cost of the overall diversified activities will be inclusive in just one cost section, and further, it will be divided by the production machine hour’s number. The result will be considered as the average rates that will be applicable to each and every product irrespective of the number and complexity of the activities, as many diversified cost activities doesn’t relate at all along with the production machine hour’s number, the consequence of this allocation is thus misleading (Mitra, 2009). The same issues existed in case of product MARTHA, i.e. the expenses were allocated more than the amount which was relating to it. Due to it over price was charged to customers and as its competitors were able to sell the product at a lower price because they applied ABC method for allocating the expenses. Hence, they were able to allocate the expenses in more appropriate manner and ascertain appropriate selling price too (Arora, 2012). It can be said as one of the reasons that its competitors had higher sales in comparison to Jackson Ltd.

Calculation of Manufacturing Overhead Rate as per Conventional Method

ABC is aimed to cover up the traditional method’s weakness and threats via containing different costing pools and further allocating all the costing pools based on its root cause. Thus, now Jackson Ltd will be able to improve its sales as well as provide products at appropriate selling price (Drury, 2013).

Advantages of ABC

Kaplan and Bruns firstly defined ABC costing in the late 1980s. It is normally seen as a contemporary alternative to absorption costing, enabling managers to understand the product and net profitability better. This furnishes the company with enhanced information to enable value-based and hence more efficient decisions (Abdel, 2011).

This method is focused on cost drivers, the activities which result in an increase in cost. Traditional absorption costing is focused on volume-based drivers like labour hours, on the other hand, ABC employs transaction-related drivers like the total amount of order received etc. Resultantly, long-run variable overheads, which are customarily considered as a fixed cost, could be traced to the product (Rajasekaran, 2010).

 

Activity-based costing (ABC) offers more of accuracy for the products regarding its costing, decision-making or leading. It boosts understanding of expenses and drivers of costs, and highlights highly expensive and non-value activities in the business, enabling managers to eliminate them from management (Kostakis, Boskou and Palisidis, 2011). ABC also effectual challenges to operating costs in such a way that it can find better ways of eliminating overheads. It also allows developed products and analysis of customer profitability. It promotes position and performance of business tools and techniques like scorecards and rapid improvements. Determination of products by using ABC method is more reliable yet accurate; it is because it aims at the impacts of activities and costs regarding the manufacturing goods (Debarshi, 2011). The complex of the selling price for multiple products as per the ABC is accurate and fair, due to the allocation of outlays in terms of related cost drivers.  

Controlling overhead containing fixed/variable make it more possible in monitoring activities. The relation between activities and costs are purely visible and are determined in ABC. This, it drives opportunities to manipulate overhead costs. Adequate details and information can be acquired in order to make better decisions in regards to profitability of various lines of product. Ascertainment of cost under ABC costing can be said more accurate and reliable as it is based on cause and effect linkage of cost relating to producing goods (Mhamdia and Ghadhab, 2012). Thus, due to same reason, appropriate allocation of overhead is possible. As fixation of the selling price for various products in case ABC costing method is done in a more appropriate manner as it is allocated on the basis of relevant cost drivers. Moreover, other information can also be obtained by this method which assists in making decisions relating to the profitability of different products (Wagener, 2013).

Calculation of cost per activity for each activity cost pool

Disadvantages of ABC

Business entities that adopt ABC method drives the threat of spending more than earning, giving much time and efforts on collecting data. Too much focus and data can frustrate the managers who are engaged in the method of ABC. However, insufficient details can result in lack of data. One other general factor that has a hand in the collapse of ABC is the failure to perform on the consequence that the data has provided. This basically occurs in business which is unwilling to put ABC in their priority.  Another disadvantage is that is not easy to choose the most appropriate cost drivers, and it is also hard to measure cost based on the activities, that are not appropriate for concerns of small manufacturing companies. It is also difficult to determine entire activities which can impact costs (Goektuerk, 2007).

Implementation of ABC method is a big project which demands considerable resources. Once it is incorporated, an ABC system demands high maintenance and is thus expensive. Data related to several activity measures need to gathered, examined and fed into the system. This method furnishes numbers like product margins, which are odds with the figures furnished by conventional costing techniques. However, managers are habitual of using the traditional methods to keep their operations running, and this system is mostly employed in performance appraisal (Zeuner, 2012). The data from ABC method has high chances of being misinterpreted and should be dealt with care when making decisions. Cost designated to items, customers and other objects have just potential relevancy. Prior to making any important decision using ABC data, managers should determine which costs are actually crucial for decisions to be taken. Reports produced by the Activity Based Costing System are not in conformation with the generally accepted accounting principles. Resultantly, a business involved in this costing method must keep two cost systems – one to prepare its external reports and one for internal usage (Kim, 2017).

References

Abdel, M., 2011. Review of Management Accounting Research. Palgrave Macmillan.

Arora, M., 2012. A Textbook of Cost and Management Accounting. Vikas Publishing House.

Debarshi. B., 2011. Management Accounting. Pearson Education.

Drury, C., 2013. Management and Cost Accounting. Springer.

Goektuerk, H., 2007. Activity-Based Costing (ABC) – Advantages and Disadvantages. GRIN Verlag.

Kim, Y., 2017. Activity Based Costing for Construction Companies. John Wiley & Sons.

Kostakis, H., Boskou, G. and Palisidis, G., 2011. Modelling activity?based costing in restaurants. Journal of Modelling in Management, 6(3), pp.243-257.

Kostakis, H., Sarigiannidis, C., Boutsinas, B., Varvakis, K. and Tampakas, V., 2008. Integrating activity?based costing with simulation and data mining. International Journal of Accounting & Information Management, 16(1), pp.25-35.

Mhamdia, A. and Ghadhab, B., 2012. Value management and activity based costing model in the Tunisian restaurant. International Journal of Contemporary Hospitality Management, 24(2), pp.269-288.

Mitra, J., 2009. Advanced Cost Accounting. New Age International.

Rajasekaran, V., 2010. Cost Accounting. Pearson Education.

Stapleton, D., Pati, S., Beach, E. and Julmanichoti, P., 2004. Activity?based costing for logistics and marketing. Business Process Management Journal, 10(5), pp.584-597.

Wagener, D., 2013. Activity-Based Costing and Its Later Development Into Activity Based Budgeting and Management. GRIN Verlag.

Zeuner, P., 2012. Activity-Based Costing. GRIN Verlag.