Traditional Volume-Based Product Costing

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Q. A. 1. - Calculate the Unit Costs for Product A and B using the traditional volume-based product costing system.

The Overhead costs of Duo plc have been allocated using the Traditional costing system in table 1. The Overhead costs have been allocated using Direct Labour Hours (DLH) of production (Direct Labour Hour absorption approach). That is, Total Overhead costs were divided by the addition of all DLHs, giving us the overhead rate per labour hour (£10.345). This method was used since, firstly, it is the basic method of traditional volume-based costing, and secondly, we are not told how to apportion reciprocal services to the two departments; therefore since we can not apportion the costs between the two departments, we must apportion the total cost as a whole. This should not affect the end result, since the total cost to be allocated would of course be the same in both cases.

Then the DLHs for Part A were added (500000 hrs for the machine department and 150000 hrs for the fitting department), and multiplied by the overhead rate per labour hour, in order to find the overhead cost to be allocated to that department (£6724146). This result was finally divided by the units produced to give us the overhead cost per unit (£22.41). The same procedure was done for Part B. The DLHs were added (600000 hrs for the machine department and 200000 hrs for the fitting department), and multiplied by the overhead rate per labour hour, in order to find the overhead cost to be allocated to that department (£8275872). This result was finally divided by the units produced to give us the overhead cost per unit (£27.59).

Q. A. 2. Using ABC calculate the unit costs for A and B.

The Overhead costs of Duo plc were now allocated using the Activity Based Costing (ABC) system, as seen in tables 2, 3 & 4. In table 2 the apportionment basis (cost drivers) for each overhead cost, and the proportion of the cost to go to each part of production was stated. In table 3 the proportion of the cost to go to each part of production was stated as a fraction.

In table 4 the fractions for each part of production (parts 1 to 4) were multiplied by the total costs, to give us the actual costs for each part of production. These were added to give us the total cost per part. Then the Product costs were calculated, by adding the part costs for each product - Product A = Part 1 + Part 2

Product B = Part 3 + Part 4

Lastly, the Product costs were divided by the number of units so as to give the the overhead cost per unit; Product A overhead cost per unit = 13.1; Product B overhead cost per unit = 36.9.

Finally, In table 5 you can see a comparison of the two methods. In the chart, on the left you can see the comparison for Product A overhead costs per unit using both methods, and on the right you can see the comparison for Product B overhead costs per unit using both methods.

It can be seen that with the ABC method, the high volume product is charged less per unit, and the low volume product is charged more per product, than what they are charged using the Traditional method. This is consistent with economies of scale achieved through high volume.

Q.B “Traditional volume-based costing systems tend to overcost high-volume products and undercost low-volume products.” Discuss the validity of this statement.

Absorption or Traditional Costing is defined by CIMA as “the procedure which charges fixed as well as variable overheads to cost units” [1]. Traditional Absorption methods were used to spread overheads to products when factory overheads were relatively small compared to material and labour costs.

The spread of overheads to products was based on the assumption that a specific work required either more labour hours or more machine hours to be carried out. Based on that management choose direct labour hours or direct labour cost methods to charge the overheads to products when work was labour intensive. Similarly...
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