CFOS/Overheads/Exercise 4.2

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Exercise 4.2

Absorption of Overheads by Activity-Based Costing Methods

The scenario is identical to that in Exercise 4.1.

A factory produces two products, electric kettles and toasters. The daily production run for each product is 1,000 units. It takes half an hour of direct labour to produce each kettle, whereas a toaster can be assembled in twenty minutes. The direct labour cost for both products is £30 per hour.

Both products are inspected. The inspectors take ten hours to check each batch of 1,000 kettles, but each batch of 1,000 toasters requires twenty inspection hours. The inspection overhead cost is £750 (or £25 per inspection hour).

As outlined in the Sample Answer to Exercise 4.1, the direct labour costs of each product are:

Kettle 1/2 direct labour hour × £30 per hour × 1,000 units = £15,000
Toaster 1/3 direct labour hour × £30 per hour × 1,000 units = £10,000
Total Direct Labour Costs: £15,000 + £10,000 = £25,000

An activity-based costing system identifies and measures the labour hours and cost required to carry out a specific activity and attaches these to the cost objects or products that benefit. Using the ABC method, how should the daily costs of inspection be allocated to the two products?

Calculate the Cost of Inspection for:

  • Kettles – Total (for a batch of 1,000):
  • Kettle – Per Unit:
  • Toasters – Total (for a batch of 1,000):
  • Toaster – Per Unit:

(Source: Adapted from Rumble 1997, Example 7.2, page 58.)

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