MANAGERIAL ACCOUNTING AND FINANCE 3A
WEEK 3 CLASS EXAMPLE:
SUGGESTED SOLUTION
Client One
Calculations
Machine set-up (R340 000*40%) = R136 000
Inspection (R340 000*60%) = R204 000
Workings Product A Product B Product C
Number of batches 3 250 4 080 800
Number of machine settings 22 750 8 160 3200 34 110
Number of inspections 19 500 8 160 8 000 35 660
Machine set-up R90 707,54 R32 535,74 R12 759,72
Inspection costs R111 553,56 R46 680,87 R45 765,56
Total manufacturing costs R202 260,10 R79 212,62 R58 524,25 R340 000
Total number of machine hours 16 250,00 25 500,00 33 333,33 75 083,33
Indirect cost using traditional
method R73 584,91 R115 471,70 R150 943,40 R340 000
Explanation
The reason for product B and C having lower profits in profits is because of high manufacturing
overhead costs allocation to those product lines compared to product A, therefore reducing
profits. The traditional method of allocating overheads uses cost drivers that are volume
related, in this case number of machine hours are being used as an allocation method.
Therefore, the high-volume products (i.e., B and C) will be allocated higher manufacturing
overheads costs compared to those with lower volumes (i.e., A).
Activity-based costing allocates manufacturing overheads based on the activities involved in
making a product (i.e., cause and effect) rather than volumes (which may be arbitrary). ABC
makes use of non-volume related cost drivers. The more complex the manufacturing process
is, the higher the manufacturing overheads costs will be allocated to the product. Product A
will be allocated higher manufacturing costs because it has higher number of activities per
batch compared to Product B and C.