ACCA/CAT

1.5 Comparing costs per driver and per unit using traditional methods and ABC

Traditional absorption costing charges overhead costs to products (or services) in an arbitrary way.

The assumption that overhead expenditure is related to direct labour hours or machine hours in the production departments is no longer realistic for the vast majority of companies.

This will lead to very different values of overheads absorbed per unit.

Illustration 3 – ABC

A manufacturing business produces two products, X and Y. The products are manufactured in batches. The batches differ slightly, in that different designs are used for each product, and each batch is for one particular design of a product.

Production data for a given period are as follows:

Product XProduct Y

Number of units produced2,0006,000

Production time1,000 hours1,500 hours

Number of batches53

Overhead costs relating to setting up the machinery for each batch run and getting the raw materials ready totalled $40,000.

This information suggests three different ways of apportioning costs:

Basis / driverUnitProduction hoursBatches

Driver volume8,0002,5008

OAR$5 per unit$16 per hour%5,000 per batch

Overheads to X2,000×5=$10,0001,000×16=$16,0005×5,000=25,000

Overheads to Y6,000×5=$30,0001,500×16=$24,0003×5,000=15,000

The selection of the cost driver can therefore make a significant difference.

Test your understanding 4

Cabal makes and sells two products, Plus and Doubleplus. The direct costs of production are $12 for one unit of Plus and $24 per unit of Doubleplus.

Information relating to annual production and sales is as follows:

PlusDoubleplus

Annual production and sales24,000 units24,000 units

Direct labour hours per unit1.01.5

Number of orders10140

Number of batches12240

Number of setups per batch13

Special parts per unit14

Information relating to production overhead costs is as follows:

Cost driverAnnual cost

Setup costsNumber of setups73,200

Special parts handlingNumber of special parts60,000

Other materials handlingNumber of batches63,000

Order handlingNumber of orders19,8000

Other overheads-216,000

Other overhead costs do not have an identifiable cost driver, and in an ABC system, these overheads would be recovered on a direct labour hours basis.

(a) Calculate the production cost per unit of Plus and of Doubleplus if the company uses traditional absorption costing and the overheads are recovered on a direct labour hours basis.

(b) Calculate the production costs per unit of Plus and of Doubleplus if the company uses ABC.

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