Question:
In the office of a firm of solicitors and estate agents there are overhead costs incurred relating to the cost of office support for the staff preparing legal documentation. There are two departments preparing legal documentation. Department A has dealt with 15 property transactions having an average value of £100,000 each, while Department B has dealt with 5 property transactions having an average value of £1m each. The total amount of the office overhead costs for the period is £100,000. The traditional approach to overhead cost has been to apportion the amount of £100,000 in proportion to the number of property deals dealt with by each department. They are now asking for an activity-based approach to costing, where the cost driver is the value of transactions in each department, because high value transactions involve more work.
Table 4.10 Traditional treatment of cleaning overhead
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A
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B
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Cost pool: office overhead, £100,000
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Cost driver: number of transactions
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15/20
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5/20
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Apportionment of cost £100,000
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£75,000
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£25,000
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Cost per transaction
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£5,000
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£5,000
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The traditional approach gives the same unit cost regardless of size of transaction.
Table 4.11 Activity-based costing for office overhead
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A
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B
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Overhead cost rate
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1,500/6,500
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5,000/6,500
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Apportionment of cost £100,000
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100,000 × 1.5/6.5
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100,000 × 5/6.5
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= £23,000
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= £77,000
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Cost per transaction
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£1,530
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£15,400
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Comment. The activity-based approach puts much more of the overhead cost on to Department B because that one is driving more of the overheads. When the cost per transaction is calculated, the activity-based approach, based on value, loads the cost towards the high-value transaction and so produces a relatively higher cost per unit for these transactions.