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THIS EXAMPLES ARE ADAPTED

FROM Cost and Management


Accounting (1996)
Prentice Hall
ISBN 0-13-205923-1

Chairs
Cost Items A B C Total
Sales and production (units) 300 100 50 450
Raw materials usage (units) 35 20 40 14,500
Direct materials cost ($/unit) $ 22.75 $ 13.00 $ 26.00 $ 9,425.00
Direct labour hours (hour/unit) 5 6 3 2,250
Direct labour cost ($/unit) $ 67.50 $ 81.00 $ 40.50 $ 30,375.00
Machine hours (hour/unit) 4 2 5 1,650
Number of production runs (runs/tota 6 2 1 9
Number of deliveries (deliveries/total 3 5 10 18
Number of receipts (receipts/total un 4 4 1 9
Number of production orders (order/t 2 5 10 17
Total area in warehouse (f2) 25000 15000 10000 50,000

Overhead costs $
Set up 5,000
Machines 6,500
Receiving 6,500
Packing 8,500
Engineering 6,500
Insurance 4,500
Utilities 15,500
Total 53,000
1. Calculate the labour hour rate. In this case, we will consider that overhead cost are absorbed on a labor hour basis

Total overhead ($) 53000


Number of hours 2250
Labour rate ($/hour) 23.55556

2. Calculate cost per unit


Cost A B C
Direct materials ($/unit) 22.75 13 26
Direct labor ($/unit) 67.5 81 40.5
Overhead ($/unit) 117.7778 141.3333 70.66667
Cost/unit 208.0278 235.3333 137.1667
ed on a labor hour basis
Products
A B C Total
Sales and production (units) 300 100 50 450
Raw materials usage (units) 35 20 40 95
Direct materials cost ($/unit) 22.75 13 26 9425
Direct labour hours (hour/unit) 5 6 3 2250
Machine hours (hour/unit) 4 2 5 1650
Direct labour cost ($/unit) 67.5 81 40.5 30375
Number of production runs (runs/total units) 6 2 1 9
Number of deliveries (deliveries/total units) 3 5 10 18
Number of receipts (receipts/total units) 4 4 1 9
Number of production orders (order/total units) 2 5 10 17
Total area in warehouse (f2) 5000 2500 1500 9,000

Overhead costs $
Set up 5000
Machines 6500
Receiving 6500
Packing 8500
Engineering 6500
Total 53000
1. Select activities to absorb overhead. Thi method is transition from traditional to ABC method
In this case, two activities are selected to absorb overhead
~Paperwork handling based on number of orders, engineering
~Other overhead based on machine usage

2. Calculate the distributing basis for each case


Material handling rate. This is based on the number of receipts
Number of orders 17
Total cost of Scheduling 6500
Cost of each order ($/order) 382.3529
Other overhead rate. This is calculated considering machine used hours. The previous overhead must be substracted
Other overheads 46500
Number of machine hours 1650
Other overhead rate ($/hour) 28.18182

3. Now we calculate the unit cost based on previous calculations


A B C
Direct material 22.75 13 26
Direct labour 67.5 81 40.5
Overhead from Scheduling 2.54902 19.11765 76.47059
Other overhead 112.7273 56.36364 140.9091
Unit cost 205.5263 169.4813 283.8797
ead must be substracted
Products
A B C Total
Sales and production (units) 300 100 50 450
Raw materials usage (units) 35 20 40 14500
Direct materials cost ($/unit) 22.75 13 26 9425
Direct labour hours (hour/unit) 5 6 3 2250
Machine hours (hour/unit) 4 2 5 1650
Direct labour cost ($/unit) 67.5 81 40.5 30375
Number of production runs (runs/total units) 6 2 1 9
Number of deliveries (deliveries/total units) 3 5 10 18
Number of receipts (receipts/total units) 4 4 1 9
Number of production orders (order/total units) 2 5 10 17
Total area in warehouse (f )
2
25000 15000 10000 50000

Overhead costs $
Set up 5,000.00
Machines 6,500.00
Receiving 6,500.00
Packing 8,500.00
Engineering 6,500.00
Insurance 4,500.00
Utilities 15,500.00
Total 53,000.00
1. Identify cost drivers
trace cost of inputs into cost pools
trace cost of pools into product costs
Cost pools Driver Value of driver
Machine usage Hour rate $ 3.9
Set ups cost/set up $ 555.6
Receiving cost/receive $ 722.2
Packaging cost/package $ 472.2
Orders cost/order $ 382.4
Insurance cost/f 2
$ 0.1
Utilities cost/f2 $ 0.3

Overhead cost A B C
Machine 15.76 7.88 19.70
Set up cost 11.11 11.11 11.11
Receiving cost 9.63 28.89 14.44
Packaging cost 4.72 23.61 94.44
Orders Cost 2.55 19.12 76.47
Insurance cost 7.50 13.50 18.00
Utilities cost 25.83 46.50 62.00
Total overhead 77.10 150.61 296.17

2. Calculate cost per unit


Cost A B C
Direct materials 22.75 13.00 26.00
Direct labor 67.50 81.00 40.50
Overhead 77.10 150.61 296.17
Unit cost 167.35 244.61 362.67
Unit cost A B C 1. Conclusions
Direct Method 208.03 235.33 137.17 ABC helps to visualize that p
Multiple allocation method 205.53 169.48 283.88 Direct method is based on l
ABC 167.35 244.61 362.67 Mutiple allocation method
Overhead is increasing, labo
Overhead A B C
Direct Method 117.78 141.33 70.67
Multiple allocation method 115.28 75.48 217.38
ABC 77.10 150.61 296.17

Overhead as a % of total cost A B C


Direct Method 57% 60% 52%
Multiple allocation method 56% 45% 77%
ABC 46% 62% 82%
. Conclusions
ABC helps to visualize that product C is absorbing a large amount of overhead
Direct method is based on labor and does not give any information on how
Mutiple allocation method is a good approximation of ABC results
Overhead is increasing, labor could be only 5% to 10% of total cost