Activity Based Costing Example / Problem:

Objectives:

1.     Perform the first stage allocation of overhead costs to the activity cost pools.

2.     Compute activity rates for the activity cost pools.

3.     Construct a table showing the overhead costs of units and four orders.

 

Fords Corporation makes a single product - a fire resistant commercial filing cabinet - that it sells to office furniture distributors. The company has a simple ABC system that it uses for internal decision making. The company has two overhead departments whose costs are listed below:

 

Manufacturing overhead                                                   Rs.5,00,000

Selling and administrative overhead                             Rs.300,000

Total overhead costs                                                         Rs.8,00,000

 

 

 The company's activity based costing system has the following activity cost pools and activity measures:

 

 Activity Cost Pool                                            Activity Measures

Assembling units                                                Number of units

Processing orders                                              Number of orders

Supporting customers                                      Number of customers

Other                                                                     Not applicable

 

 

Costs assigned to the "other" activity cost pool have no activity measure; they consist of the costs of unused capacity and organization-sustaining costs - neither of which are assigned to products, orders or customers.

 

Fords Corporation distributes the costs of manufacturing overhead and of selling and administrative overhead to the activity cost pools based on employee interviews, the results of which are reported below:

 

Distribution of Resource Consumption Across Activity Cost Pools

 

	Assembling Unit	Processing	Orders	Supporting	Customers	Other	Total
Manufacturing overhead	50%	5%	10%	100%	Selling and administrative	10%	100%
Overhead
Total activity	1,000 units	250 orders	100 customers	--	--

 

Required:

Perform the first stage allocation of overhead costs to the activity cost pools.

Compute activity rates for the activity cost pools.

OfficeMart is one of the Fords Corporation's customers. Last year OfficeMart ordered filing cabinets four different times. OfficeMart ordered a total of 80 cabinets during the year. Construct a table showing the overhead costs of these 80 units and four orders.

 

Solution:

1. The first stage allocation of costs to the activity cost pools appears below:

                                         Activity Cost Pools

	Assembling Unit	Processing	Orders	Supporting	Customers	Other	Total
Manufacturing overhead	50%	5%	10%	100%	Selling and administrative	10%	100%
Overhead
Total activity	1,000 units	250 orders	100 customers	--	--

 

 

                                                     

2. The activity rates for the activity cost pools are:

Assembling Unit	Processing	Orders	Supporting	Customers	Other	Total
Manufacturing overhead	Rs. 2,50,000	Rs. 1,75,000	Rs. 25,000	Rs. 50,000	Rs. 5,00,000
Selling and administrative	Rs. 30,000	Rs. 75,000	Rs. 60,000	Rs. 3,00,000
overhead
Total activity	Rs. 2,80,000	Rs. 3,10,000	Rs. 1,00,000	Rs. 1,10,000	Rs. 8,00,000
Activity Cost Pools	Total Cost	Total Activity	Activity Rate
Assembling units	Rs. 2,80,000	1,000 units	Rs.280 per unit
Processing orders	Rs. 3,10,000	250 units	Rs.1,240 per order
Supporting customers	Rs. 1,00,000	100 customers	Rs.1,000 per customer

 

 

 

3. The overhead cost for the four orders of a total of 80 filing cabinets would be computed as follows:

  Activity Cost Pools              Total Cost              Total Activity          Activity Rate

Assembling units   Rs.280 per unit       80 units   Rs.22,400

Processing orders Rs.1,240 per order 4 units     Rs.4,960

Supporting customers          Rs.1000 per customer           Not applicable      

 

 

4. The product and customer margin can be computed as follows:

  Filing Cabinet Product Margin:                           

Sales (Rs.595 per unit × 80 units)                       Rs.47,600

Cost:                       

     Direct materials (Rs.180 per unit × 80 units) Rs.14,400               

     Direct materials (Rs.50 per unit × 80 units)   4,000      

     Volume related overhead (above)  22,400    

     Order related overhead (above)     4,960       45,760

                               

                                                                                         Rs.1,840

                                                                                    ==========

Customer Profitability Analysis - OfficeMart                      

Product margin (above)                                                   Rs.1,840      

Less: Customer support overhead (above)       1,000      

                                 

                                                                                        Rs.840            

                                                                                  ===========