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Activity Based Costing Example/Problem:

Ferris Corporation makes a single product - a fire resistant commercial filing cabinet - that it sells to office furniture distributors. The company has a simple ABC system that it uses for internal decision making. The company has two overhead departments whose costs are listed below:

The company's activity based costing system has the following activity cost pools and activity measures:

 Activity Cost Pool Activity Measures Assembling units Number of units Processing orders Number of orders Supporting customers Number of customers Other Not applicable

Costs assigned to the "other" activity cost pool have no activity measure; they consist of the costs of unused capacity and organization-sustaining costs - neither of which are assigned to products, orders or customers.

Ferris Corporation distributes the costs of manufacturing overhead and of selling and administrative overhead to the activity cost pools based on employee interviews, the results of which are reported below:

 Distribution of Resource Consumption Across Activity Cost Pools Assembling Units Processing Orders Supporting Customers Other Total Manufacturing overhead 50% 35% 5% 10% 100% Selling and administrative overhead 10% 45% 25% 20% 100% Total activity 1,000 units 250 orders 100 customers -- --

Required:

1. Perform the first stage allocation of overhead costs to the activity cost pools.
2. Compute activity rates for the activity cost pools.
3. OfficeMart is one of the Ferris Corporation's customers. Last year OfficeMart ordered filing cabinet four different times. OfficeMart ordered a total of 80 cabinets during the year. Construct a table showing the overhead costs of these 80 units and four orders.

Solution:

1. The first stage allocation of costs to the activity cost pools appears below:

 Activity Cost Pools Assembling Units Processing Orders Supporting Customers Other Total Manufacturing overhead \$250,000 \$175,000 \$25,000 \$50,000 \$500,000 Selling and administrative overhead 30,000 135,000 75,000 60,000 300,000 Total activity \$280,000 \$310,000 \$100,000 \$110,000 \$800,000

2. The activity rates for the activity cost pools are:

 Activity Cost Pools Total Cost Total Activity Activity Rate Assembling units \$280,000 1,000 units \$280 per unit Processing orders \$310,000 250 units \$1,240 per order Supporting customers \$100,000 100 customers \$1,000 per customer

3. The overhead cost for the four orders of a total of 80 filing cabinets would be computed as follows:

 Activity Cost Pools Total Cost Total Activity Activity Rate Assembling units \$280 per unit 80 units \$22,400 Processing orders \$1,240 per order 4 units \$4,960 Supporting customers \$1000 per customer Not applicable

4. The product and customer margin can be computed as follows:

 Filing Cabinet Product Margin: Sales (\$595 per unit × 80 units) \$47,600 Cost: Direct materials (\$180 per unit × 80 units) \$14,400 Direct materials (\$50 per unit × 80 units) 4,000 Volume related overhead (above) 22,400 Order related overhead (above) 4,960 45,760 \$1,840 ========== Customer profitability Analysis - OfficeMart Product margin (above) \$1,840 Less: Customer support overhead (above) 1,000 \$840 ===========

Relevant Articles:

 » Definition and Explanation of Activity Based Costing » Treatment of Costs Under Activity Based Costing (ABC) System » Activity Based Costing and Top Management » Activity Based Costing, GAAP and External Reports » Designing and Implementing Activity Based Costing System » Targeting Process Improvements » Advantages, Disadvantages and Limitations of Activity Based Costing » Activity Based Costing Example

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