Tutorial 10.docx - Tutorial 10 Activity Based Costing and...

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Tutorial 10: Activity Based Costing and Management In this tutorial, we will discuss two problems. The first problem deals with the product costing mechanism for a firm following ABC. You are asked to find the profit margins based on ABC information and recommend a set of actions to the management that is struggling to make money. Problem 2 deals with customer profitability analysis. Let us look at the first problem. Zeus optical recently expanded its product line by making eyepieces for telescopes but finds it difficult to make any profit from this product. However, the firm seems to be making a nice profit from the lenses for digital SLR market. You have the relevant data for the three product lines: Eyepieces, Binoculars and Camera Lenses. The total manufacturing overhead for the firm is $1,161,100. You have also collected the following operation data for the three product lines regarding batch sizes, # of receiving transactions, # of products and components used for each unit of final product. Further, you know the details of the activities that are responsible for generating the overhead expenses and its breakup into individual cost pool amounts. There are five sub-divisions in this problem. In the first part, you need to verify the profit margin using the current costing system. We know the price, variable cost, UMC and unit profit margin. We can also calculate the allocated fixed cost. It is given in the problem that the overhead cost is allocated based on number of direct labor hours. We are given the number of direct labor hours per unit of each of the three products and we also know the volume manufactured for each of the three products. By multiplying the number of labor hours by the respective volume of the products, we get the estimated number of labor hours to be consumed in the production process as 68,300 hours. By dividing the total estimated overhead of $1,161,100 by the denominator volume of 68,300 labor hours, we get the allocation rate as $17 per direct labor hor. BY multiplying this rate by the number of hours to make one eyepiece, we get the overhead cost allocated to eyepiece as $25.50. We can similarly estimate the overhead cost for binoculars and camera lens as $32.30 and $35.70 respectively. Subtracting the overhead cost form the UMC, we verify that the profit margin of the products exactly match the profit margin provided in the problem. In the next part, you are required to estimate the cost driver rate for each activity cost pool. The problem tells you that you need to form five cost pools. Volume related costs are to be allocated using labor hours. Labor related and machine related costs form this cost pool and it amounts to $341,500 + $273,200 = $614,700. The denominator volume for this pool is 68,300 as calculated in the last part.

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