ABC - Clarkie\'s electrical solution PDF

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Clarkie’s Electrical – ABC problem solution a) Predetermined overhead rate = total overhead/direct labour cost = $2,900,000/$1,000,000 = $2.90 per dollar of direct labour cost (or 290% of direct labour cost). Total product cost = direct material+direct labour+allocated overhead: Direct material Direct labour Allocated overhead

$500 $200 $580 ($200 x $2.90) Total product cost: $1280 (batch of 10 units)

b) Cost pool Labour related overhead Material ordering Material inspection Equipment set-up Quality control Machine related costs Miscellaneous indirect costs

Cost hierarchy categorisation Unit level Batch level Batch level Batch level Batch level Unit level Unit level

c) After identifying the activities and cost drivers, calculate the cost driver rates as follows:       

Labour related overhead activity cost pool: $400,000/$1,000,000 direct labour cost = $0.40 per dollar of direct labour cost (or 40%) Material ordering activity cost pool: $100,000/5,000 purchase orders = $20 per purchase order Material inspection activity cost pool: $600,000/4,000 receiving reports = $150 per receiving report Equipment set-up activity cost pool: $200,000/1,000 set-ups = $200 per set-up Quality control activity cost pool: $400,000/2,000 inspections = $200 per inspection Machine related overhead costs activity cost pool: $800,000/40,000 = $20 machine hour Miscellaneous indirect costs activity cost pool: $400,000/$4,000,000 prime product costs = $0.10 per dollar of prime costs (or 10%)

Finally, calculate the total product cost using the cost driver rates above: Cost type Direct material Direct labour       

Cost amount $500 $200 Total direct cost: $700 Labour related overhead $80 ($0.40 x $200 of direct labour cost) Material ordering $40 ($20 x 2 purchase orders) Material inspection $300 ($150 x 2 receiving reports) Equipment set-up $200 ($200 x 1 set-up) Quality control $200 ($200 x 1 inspection) Machine related costs $200 ($20 x 10 machine hours) Miscellaneous indirect costs $70 ($0.10 x $700 of prime costs) Total allocated overhead cost: $1,090

Total product cost: $1,790 (batch of 10 units) d) The traditional system has undercosted the job by $510 (ie, $1,790 ABC system total product cost - $1,280 traditional system total product cost). More specifically, this is because different amounts of overhead are allocated to the job using each costing method. With the traditional costing system, $580 of overhead is allocated to the job but with the ABC costing system $1,090 of overhead is allocated. The underlying reason for this is because, based on ABC, the job is using more overhead resources than indicated by the traditional overhead allocation system (which is based on direct labour cost)....