Activity Based Costing vs Traditional Overhead Allocation: A Cost Analysis

Manufacturing Company's Cost Analysis through Activity Based Costing and Traditional Overhead Allocation

CompanyX Ltd is a manufacturing company.   Two of the products that are produced for the company, C1 and T1 do not appear to be showing a profit, despite generating a high volume of sales for the company.  On further analysis of the figures, it was noted by the financial director that the overhead costs have grown as a proportion of total costs over the last five years.  The company CEO has recently heard of a new method of costing products that allocates overheads using Activity Based Costing.  Currently the company allocates total company overheads of €2,400,000 based on a predetermined overhead rate using total machine hours.  The CEO wants to set up a project to allocate these overheads based on activities.  It has been decided to allocate overheads to the two products C1 and T1 using Activity Based Costing as an initial trial.  

The following information has been provided for Production Overhead:

The two products have the following unit costs

The information on the activity usage of each product is as follows

 Provide the following:

Show using calculations the cost per unit of C1 and the T1 using the traditional method and add 60% markup to calculate the selling price of each. (Assume Machine hours are used to allocate overheads).    (10 Marks)

Show using calculations the cost per unit of C1 and the T1 using Activity Based costing and add 50% markup to calculate the selling price of each.     (25 Marks)

Provide a memorandum to the managing director explaining the differences between Activity Based Costing and the traditional blanket overhead rates.  Compare the results of both methods of overhead allocation and make a recommendation on which overhead allocation method should be used.  Support your answer with reasons.   (15 Marks)

CompanyY is a subsidiary of CompanyX.  It commenced trading on the 1^st of July 2022. producing and selling a single product a room freshener.  The following budgeted information is available:

Fixed Production overhead is €2,000 per month and is absorbed based on budgeted production levels of 1,000 units per month.

Fixed selling and distribution expenses are budgeted at €2,500 per month.

Fixed costs are assumed to be incurred evenly throughout the year.

The selling price is budgeted to be €70 per unit.

Actual costs and selling price are as per budget for the first two months of production.

There was no opening inventory in July.

The following data will apply to July and August 2022.

Prepare a schedule to calculate the opening and closing inventory. (5 Marks)

Prepare a profit statement using Absorption costing for both July and August.    (15 Marks)

Prepare a profit statement using Marginal (Variable) Costing for both July and August.   (15 Marks)

Provide a reconciliation of the difference between the Variable Costing profit and the Absorption costing profit. (5 Marks)

Outline the arguments in favour of absorption costing and those in favour of variable (Marginal) costing.     (10 Marks)