Jackson Ltd manufactures two products FRED and MARTHA. The firm uses a single plantwide overhead rate based on direct
labour hours. Product costing data is as follows:
Production Quantity 1000 Units 5000 Units
Direct material $40 $60
Direct labour $30 (2 hours) $45 (3 hours)
Manufacturing overhead $96 (2 hours) $144 (3 hours)
Total cost per unit $166 $249
Manufacturing overhead is currently calculated by using a conventional volume-based approach using a predetermined
overhead rate based on the number of direct labour hours used to produce the product. The manufacturing overhead
budget consists of the following overhead costs:
Activity Cost Pool Cost driver
Machine related costs $450,000
Setup and inspection $180,000
Plant related costs $96,000
Currently Jackson prices its products at 120% of total manufacturing cost. It has noticed that a competitor is producing
MARTHA and has been pricing its products at $230 each and that sales of MARTHA have been declining over the last year.
Because of this the accountant at Jackson has suggested that Activity Based costing should be considered. He suggested
the following details
Activity Cost Pool Cost driver Budgeted level
Machine related costs Machine hours 9000 hours
Setup and inspection Number of production runs 40 runs
Engineering Engineering change orders 100 change orders
Plant related costs Square footage of space 1,920 sq. ft
You have gathered some further information about the two products :
Each FRED requires 4 machine hours, whereas each MARTHA requires 1 machine hour
The FRED is manufactured in production runs of 50 units each .Each MARTHA is manufactured in
250 unit batch
Three quarter of the engineering activity ,in terms of change orders ,is related to FREDs.
The plant has 1,920 square feet of space, 80 per cent of which is used in the production of FREDs.
(a) Calculate the cost per unit for FREDs and MARTHAs using the conventional (traditional) approach when calculating
(b) Calculate the cost per activity for each activity cost pool.
(c) Calculate the product cost per unit for FREDs and MARTHAs using Activity Based Costing.
(d) Using the same pricing approach as above(120% of total manufacturing cost) calculate the price
that would be charged for FREDs and MARTHAs using Activity Based costing.
(e ) Based on your calculations using Activity Based costing explain how the conventional volume based approach to
allocating overhead has led to mispricing the products.
(f) What are the benefits that would come from introducing Activity Based costing(ABC)?
(g) Are there any disadvantages from using ABC ?
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