Assignment: Application of Activity-Based Costing
Nina Audrey started Nina Interiors, a niche furniture brand, 10 years ago. She ran the business as a sole proprietorship. While she has 50 skilled carpenters and 5 sales people on her payroll, she has been taking care of the accounting by herself. Now, she intends to offer 40% of the ownership to public in next couple years and is willing to make changes and has hired Tracy as a management accountant to organize and improve the accounting systems.
Nina Interior's total budgeted manufacturing overheads cost for the current year is Ugx. 111,240,000 and budgeted total labor hours are 20,000. Alison the financial accountant has been applying traditional costing method during the whole 10 years period.
Nina Interior's sofas includes the 2-set, 3-set and 6-set options. State House recently placed an order for 150 units of the 6-set type. The order is expected to be delivered in one-month time. Since it is a customized order, State House will be billed at cost plus 25%.
Tracy is not a fan of traditional costing system. She believes that the benefits of activity-based costing system exceeds its costs, so Tracy has sat down with Aaron Mason, the chief engineer, to identify the activities which the firm undertakes in its sofa division.
Next, Tracy calculated the total cost that goes into each activity, identified the cost driver that is most relevant to each activity and calculated the activity rates.
The results are summarized below:
|
Activity
|
Amount (Ugx)
|
Relevant Cost Driver
|
Activity level
|
|
Production of components
|
20,310,000
|
Machine hours
|
25,000
|
|
Assembly of components
|
15,200,000
|
Number of labor hours
|
20,000
|
|
Packaging
|
2,130,000
|
Units
|
5,000
|
|
Shipping
|
6,000,000
|
Units
|
5,000
|
|
Setup costs
|
3,4000,000
|
Number of setups
|
240
|
|
Designing
|
1,200,000
|
Designer hours
|
1,000
|
|
Product testing
|
2,400,000
|
Testing hours
|
500
|
Once the order was ready for packaging, Alison gave you a summary of total cost incurred, and a statement of activities performed (also called the bill of activities) as shown below:
|
Order No: 1502021
Customer: State House
Units: 150
Type: 6 Set
|
|
Cost of direct materials
|
Ugx 15,000,000
|
|
Cost of purchased components
|
Ugx 13,500,000
|
|
Labor cost
|
Ugx 11,560,000
|
|
|
|
|
|
Activity
|
Relevant Cost Driver
|
Activity Usage
|
|
Production of components
|
Machine hours
|
320
|
|
Assembly of components
|
Number of labor hours
|
250
|
|
Packaging
|
Units
|
150
|
|
Shipping
|
Units
|
150
|
|
Setup costs
|
Number of setups
|
15
|
|
Designing
|
Designer hours
|
70
|
|
Product testing
|
Testing hours
|
22
|
Task
i. Help management of Nina interiors to calculate the total costs using activity-based costing.
ii. Why would Tracy prefer Activity-based costing rather than the Traditional costing method?