A Product Cost Statement under traditional Absorption Costing is prepared using a single volume-based cost driver, while the Activity-based Costing Method allocates overheads based on multiple cost drivers. ABC provides a more accurate representation of costs per product compared to traditional costing, which can result in misallocation of overheads.
To prepare a Product Cost Statement under both traditional Absorption Costing and Activity-based Costing (ABC) Method, we need to allocate the costs based on their drivers differently. In traditional costing, overheads are often allocated based on a single volume-based cost driver such as direct labor hours or machine hours. In contrast, ABC allocates overheads more precisely based on various cost drivers associated with each activity. Let's demonstrate this with an illustrative example.
Traditional Absorption Costing
The overhead cost from Department A (€550,000) is labor-intensive, so it could be distributed based on labor hours. Department B's overhead (€750,000) is machine-intensive and would be allocated based on machine hours.
Activity-based Costing
Under ABC, the overhead costs are split further into production scheduling/machine setup costs and costs for receiving/inspecting based on relevant activity drivers such as the number of setups or purchase requisitions.
Comparing both methods, ABC often gives a more accurate reflection of the actual resource consumption by different products, which can lead to better decision-making. Traditionally, indirect costs might be over- or under-applied to certain products, not reflecting the actual cost to produce each product.
This question is about preparing a Product Cost Statement under traditional Absorption -Costing and Activity-based Costing Method and comparing the results.
Jumbo Auto Ltd. produces three products 'P', 'Q' and 'R' for which the standard costs and quantities per unit are as follows:
PRODUCTS
Direct material
Direct wages
Labour hours per unit
Machine hours per unit
No. of Purchase requisition
No. of set ups
P
5,000
100
3
4
600
140
Receiving/Inspecting
Q
15,000
80
4
4
900
110
Production overhead split by departments:
Department A
550,000
Department B
750,000
1,300,000
Department 'A' is labor intensive while Department 'B' is machine intensive. Total labor hours in Department A = 55,000 and total machine hours in Department B = 150,000
Production overhead split by activity:
Production Scheduling/Machine Set up
R
22,500
60
5
7
1,000
150
700,000
600,000
1,300,000
No. of batches received/inspected
No. of batches for scheduling and set up
Required:
a. Prepare Product Cost Statement under traditional Absorption Costing and Activity-based Costing Method.
b. Compare the results under two methods:
2,500
400
Ignore any typos or irrelevant parts of the questions being asked.