Question 1 June 2014

Dear Mr Moffat

Coudl you please help me to understand which OAR should have been used in order to answer below question correctly.
The answer provided by ACCA used the labour hours, whereas the report says that the Machine hours should have been used.

Thanks a lot for your help on this.

Q1a – June 2014

Duff Co manufactures three products, X, Y and Z. Demand for products X and Y is relatively elastic whilst demand for product Z is relatively inelastic. Each product uses the same materials and the same type of direct labour but in different quantities. For many years, the company has been using full absorption costing and absorbing overheads on the basis of direct labour hours. Selling prices are then determined using cost plus pricing. This is common within this industry, with most competitors applying a standard mark-up.

Budgeted production and sales volumes for X, Y and Z for the next year are 20,000 units, 16,000 units and 22,000 units respectively.

The budgeted direct costs of the three products are shown below:
product x y z
$ per unit $ per unit $ per unit
direct materials 25 28 22
direct labour ($12 per hour) 30 36 24

In the next year, Duff Co also expects to incur indirect production costs of $1,377,400, which are analysed as follows:
cost pools $ cost drivers
machine set up costs 280,000 number of batches
material ordering costs 316,000 number of purchase orders
machine running costs 420,000 number of machine hours
general facility costs 361,400 number of machine hours
1,377,400

The following additional data relate to each product:
product x y z
batch size (units) 500 800 400
no of purchase orders per batch 4 5 4
machine hours per unit 1.5 1.25 1.4

Duff Co wants to boost sales revenue in order to increase profits but its capacity to do this is limited because of its use of cost plus pricing and the application of the standard mark-up. The finance director has suggested using activity based costing (ABC) instead of full absorption costing, since this will alter the cost of the products and may therefore enable a different price to be charged.

Required:

(a) Calculate the budgeted full production cost per unit of each product using Duff Co’s current method of absorption costing. All workings should be to two decimal places. (3 marks)

Full budgeted production cost per unit using absorption costing
Product X Y Z Total
Budgeted annual production (units) 20000 16000 22000
Labour hours per unit 2.5 3 2
Total labour hours 50000 48000 44000 142000

Overhead absorption rate = $1,377,400/142,000 = $9·70 per hour
Product X Y Z
$ per unit $ per unit $ per unit
Direct materials 25 28 22
Direct labour 30 36 24
Overhead ($9·70 x 2·5/3/2) 24.25 29.10 19.40
–––––– –––––– ––––––
Full Cost per unit 79.25 93.10 65.40
–––––– –––––– ––––––

Part (a) was a 3 mark question asking for a calculation of the absorption cost for each of three products. The total overheads had to be divided by the total machine hours and then allocated to each product on the basis of the number of machine hours used.

The expectation would have been that all F5 candidates were able to answer this requirement as it is a common calculation under absorption costing. However, common mistakes included:

• Dividing the overheads by the number of labour hours rather than machine hours i.e. using an incorrect method for absorption.
• Dividing the overheads by the total number of units and then working out a cost per unit by including this figure.

Regards

Gabbi