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    Cost per unit under ABC & traditional costing

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    Module 4 - Case
    Activity Based Costing

    The New Millenium Manufacturing Company produces two products. One is a millenium surf kit. The other product is a professional surf-board (short board) used in world class surfing competition. Most of the sales come from the millenium surf product, but recently sales of professional boards have been increasing. The following information relates to the products for the most recent fiscal year:
    Millenium Surf Kit Professional Board
    Sales and production (units) 1500 500
    Sales price $980 $650
    Labor hour required per unit 6 9
    Machine hour required per unit 5 8
    Unit costs:
    Direct materials $212 $265
    Direct labor $85 $85
    Variable overhead $70 $90

    Concerning the current system's effectiveness in valuing costs of two products, Millenium Manufacturing Company hires a consultant to create an activity-based costing system. The consultant developed the following data:

    Cost pool Cost driver Tot. amount Surf Kit Prof. Board
    Equipment Machine hours $ 90,000 7,500 4,000
    Material order No. of orders 33,000 150 475
    Machine setups No. of setups 30,600 70 216
    Quality control No. of insp. 58,000 5 25

    1. Calculate the manufacturing overhead rate based on labor hours and machine hours (two separate computations).
    2. Determine the cost to manufacturing one unit of each model using two different traditional approaches; direct labor hours and machine hours.
    3. Determine the cost to manufacturing one unit of each model using the activity-based costing data presented above.
    4. Is the millenium surf kit as profitable as the company may think it is based on its present system?
    5. What should Millenium Manufacturing Company do to improve its profitability?

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    Solution Preview


    Activity-Based Costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to products and services according to the actual consumption by each in order to arrive at the actual cost of products and services.

    In Activity based costing costs of all organization’s resources are assigned to the products and services that the organization manufacture/render. The main intention behind the assignment of resource cost to the product/services is to find out the cost of the product and the resultant profitability.

    The main purpose of Activity Bases costing is the elimination of unprofitable activities in the organisation.Further; to identify the overpriced activities in order to lower the prices of those activities. It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.
    Following are the steps to be followed in ABC.

    1. Identify cause and effect relationships of all the activities to assign costs to the activities.

    2. Costs of the activities are to be computed .

    3. Then the cost of each activity is assigned to each product/service to the extent that the product/service uses the activity.

    4. Then the products with high overhead costs are to be identified and the efforts need to be made to reduce the costs of the costs .

    ABC costing helps in capital budgeting:
    Capital budgeting is the planning process used to determine profitability or otherwise of firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research and development projects.

    ABC costing helps the organization in capital budgeting decisions.

    1.ABC costing helps the Organization to know which of the activities are true contributors to and ...

    Solution Summary

    The solution contains the computation of cost per unit under traditional systems (machine hours & labor hours) and activity based costing system and also ascertaining the profitability of different products