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Sir,
the other day you did quite mention that there’s been a change to the lecture notes of F5 on activity based costing and the answer is both statements are true but in the revision mock exam which I did couple of minutes ago, only statement 2 is correct.
This question:
Which of the following statements about Activity Based Costing is/are true?
1. Traditional absorption costing tends to under allocate overhead costs to low products.
2. A cost driver is any factor that causes a change in the cost of an activity.Now I’m very confused.
Second question :
A contract requires 100 hours of skilled labour.
Labour is paid $5 per hour.
Labour is currently fully occupied making another which is generating a contribution of $8 per unit.
Each unit of the other product requires 2 hours of skilled labour.What is the relevant cost for labour? (Answer is 900 but how?)
First question:
If I did say that, then either I got confused or you misunderstood me.
Let me explain with a small example!
Suppose we produce 100 units of A and 1000 units of B
Suppose the total set-up costs are $2,200.
Then using traditional absorption they will be absorbed at $2,200/1,100 = $2 per unit.
So the total overhead charged for product A is 100 x $2 = $200Suppose that we use ABC and that each product needs 1 set-up (regardless of how many units are produced). That means it is $2,200 /2 = $1,100 per set-up.
So since product A needs set-up then the total overhead for product A is $1,100Absorption costing will have under-allocated the overhead cost. (It is not automatically the case, but it does tend to under-allocate)
Seceding question:
When labour is fully occupied elsewhere, then the relevant cost is: labour cost per hour + lost contribution per hour. (The logic of this is explained in the free lecture on relevant costing).
In this question, about is paid $5 per hour.
The other product takes 2 hours per unit and gives a contribution of $8 per unit. So the contribution that will be lost by not making it is $8 / 2 = $4 per hour.So the relevant cost of labour is $5 + $4 = $9 per hour.
100 hours are required so the total cost is 100 x $9 = $900
Yes – both statements are correct.
(I do apologise – what has happened is that the answer in the exam has been corrected, but not yet uploaded. It is my fault and is because I am busy providing pop-up answers to all the questions before re-uploading it, and given there are several 100 questions in the bank it is taking a bit of time 🙁 )
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