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# THIS EXAMPLES ARE ADAPTED FROM Cost and Management Accounting (1996) Prentice Hall ISBN 0-13-205923-1

Chairs A B C Cost Items 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/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 2 Total area in warehouse (ft ) 25000 15000 10000 50,000

Overhead costs Set up Machines Receiving Packing Engineering Insurance Utilities Total

## \$ 5,000 6,500 6,500 8,500 6,500 4,500 15,500 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 (\$) Number of hours Labour rate (\$/hour) 2. Calculate cost per unit Cost Direct materials (\$/unit) Direct labor (\$/unit) Overhead (\$/unit) Cost/unit 53000 2250 23.55556

## ed on a labor hour basis

A Sales and production (units) Raw materials usage (units) Direct materials cost (\$/unit) Direct labour hours (hour/unit) Machine hours (hour/unit) Direct labour cost (\$/unit) Number of production runs (runs/total units) Number of deliveries (deliveries/total units) Number of receipts (receipts/total units) Number of production orders (order/total units) Total area in warehouse (ft2) Overhead costs Set up Machines Receiving Packing Engineering Total \$ 5000 6500 6500 8500 6500 53000 300 35 22.75 5 4 67.5 6 3 4 2 5000

## Total 50 40 26 3 5 40.5 1 10 1 10 1500 450 95 9425 2250 1650 30375 9 18 9 17 9,000

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 substrac 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

o ABC method

## ous overhead must be substracted

A Sales and production (units) Raw materials usage (units) Direct materials cost (\$/unit) Direct labour hours (hour/unit) Machine hours (hour/unit) Direct labour cost (\$/unit) Number of production runs (runs/total units) Number of deliveries (deliveries/total units) Number of receipts (receipts/total units) Number of production orders (order/total units) Total area in warehouse (ft2) Overhead costs Set up Machines Receiving Packing Engineering Insurance Utilities Total

Products B C 300 100 35 20 22.75 13 5 6 4 2 67.5 81 6 2 3 5 4 2 25000 \$ 5,000.00 6,500.00 6,500.00 8,500.00 6,500.00 4,500.00 15,500.00 53,000.00 4 5 15000

Total 50 40 26 3 5 40.5 1 10 1 10 10000 450 14500 9425 2250 1650 30375 9 18 9 17 50000

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 2 cost/ft Insurance \$ 0.1 2 cost/ft Utilities \$ 0.3 Overhead cost Machine Set up cost Receiving cost Packaging cost Orders Cost Insurance cost Utilities cost Total overhead A 15.76 11.11 9.63 4.72 2.55 7.50 25.83 77.10 B C 7.88 19.70 11.11 11.11 28.89 14.44 23.61 94.44 19.12 76.47 13.50 18.00 46.50 62.00 150.61 296.17

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 Direct Method Multiple allocation method ABC Overhead Direct Method Multiple allocation method ABC Overhead as a % of total cost Direct Method Multiple allocation method ABC

## C 137.17 283.88 362.67 C 70.67 217.38 296.17 C 52% 77% 82%

1. Conclusions ABC helps to visualize tha Direct method is based o Mutiple allocation metho Overhead is increasing, la

. 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