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Activity Level Activity Cost-Driver Base Cost Product A Product B Production setup Number of setups 90,000...

Activity Level
Activity Cost-Driver Base Cost Product A Product B
Production setup Number of setups 90,000 11 19
Materials handing & requisition Number of parts per unit 15,000 6 18
Packaging & shipping Number of units shipped 45,000 60,000 120,000
Total overhead 150,000

Paris, Inc, Produces two products, Product A and Product B. If currently allocates overhead costs using direct-labor hours, but the controller has recommended an activity-based costing (ABC) system using the following data:

B. Compute the amount of overhead to be allocated to each product under ABC.

C. Should the company follow controller's recommendation? Explain your answer.

business   accounting   
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Answer #1

Paris Inc Overheads to be allocated to each product under Activity Based Costing (ABC) Overheads Allocated TOTAL Product A Product B Cost DriverRatio Activity Production Setup Materials HandlingReqisitionNo of parts per unit 11:19 33,000 57,000 ^:118.3,fi)11,2 No of Setups 90,000 15,000 No of Units shipped 60,000:120,00015,000 30,000 45,000 Packaging& Shipping TOTAL OVERHEADS ALLOCATED 51,750 98,250 150,000

Evaluating Controllers recommendation to follow ABC: Overheads are allocated using direct labour hour under traditional costing approach. It is suitable where indirect costs vis-à-vis direct costs are lower or even insignificant. One Blanket rate is applied throughout to allocate overheads. Traditional approach can result in under-absoprtion or over-absorption In cases of costs of various indirect nature, those can be found out to be more specific to some units and less relating to others. This is done under ABC, under which the indirect costs are divided in various activities and then such costs are allocated as per activities carried out by various centres or products. This results in more correct and accurate allocation of overheads projecting good costing principles. It allows companies to understand the true cost and profitability of individual units produced or services rendered. As per above discussion, the company should be following controllers recommendation of implementing ABC.

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