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Class 4: Cost allocation, job costing and ABC 1. Kingsway Ltd. You have been asked to suggest a method of deducing the full cost of various...


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Class 4: Cost allocation, job costing and ABC

 

1. Kingsway Ltd.

 

You have been asked to suggest a method of deducing the full cost of various production orders of

 

Kingsway Ltd. This method will be used as a basis for setting prices. The production orders vary greatly

 

in size and nature from one to the next.

 

The following information has been taken from the budget for the forthcoming financial year: Direct labour hours:

 

Machine hours 100,000 hours

 

90,000 hours Manufacturing costs:

 

Power

 

Direct materials

 

Machine maintenance and repairs

 

Factory heat and light

 

Lubricants and cleaning materials

 

Direct labour

 

Depreciation:

 

factory buildings

 

machinery

 

Indirect labour £

 

40,000

 

200,000

 

38,000

 

4,000

 

6,000

 

600,000

 

130,000

 

402,000

 

100,000

 

1,520,000 The business is not departmentalised for accounting purposes.

 

All direct labour is paid the same hourly rate.

 

Required:

 

1. Explain the difference between direct and indirect costs. Give an example of each. Can a given

 

cost item be both a direct cost and an indirect cost? Why do managers distinguish between

 

direct costs and indirect costs?

 

2. Calculate two feasible overhead rates for the year.

 

3. Prepare full costings for Order No 101 using each of the rates calculated in (2) (that is, two

 

separate costings).

 

The cost sheet for Order No 101 shows the following:

 

Raw materials

 

£5,000

 

Direct labour hours 4,000 hours Machine hours 1,900 hours. 4. State briefly which of the two bases of overheads you prefer and why. How might you improve on

 

the two possible costs that you derived in (3) by taking a slightly different approach? 13 2. Edgware Insight

 

Edgware Insight provides outsourcing services and advice to both government and corporate clients.

 

For costing purposes, Edgware Insight classifies its departments into two support departments

 

(Administrative/ Human Resources and Information Systems) and two operating departments

 

(Government Consulting and Corporate Consulting). For the first quarter of this year, Edgware Insight

 

incurs the following costs in its four departments:

 

Administrative/Human Resources (A/HR) £50,000 Information Systems (IS) £280,000 Government Consulting (GOVT) £875,600 Corporate Consulting (CORP) £1,245,200 The actual level of support relationships among the four departments for the first quarter of this year

 

was: USED BY SUPPLIED

 

BY A/HR

 

IS A/HR IS GOVT CORP - 35% 40% 25% 20% - 20% 60% The Administrative/Human Resource support percentages are based on headcount. The Information

 

Systems support percentages are based on actual hours of computer time used.

 

Required:

 

1. Allocate the two support department costs to the two operating departments using the

 

following methods:

 

(a) Direct method

 

(b) Step-down method (allocate Administrative/Human Resources first)

 

(c) Step-down method (allocate Information Systems first).

 

Compare and explain the differences in the support department costs allocated to each operating

 

department.

 

2. What criteria could determine the sequence for allocating support departments using the stepdown method? What criterion should Edgware Insight use if government consulting jobs require

 

the step-down method for tendering purposes?

 

3. Why do conventional product costing systems allocate support department costs first to the

 

operating departments before assigning them to individual jobs?

 

Clearly show your workings. 14 3. ABC Bank (collected for marking)

 

ABC Bank is a multinational bank with headquarters in London. It has three major divisions:

 

investment, retail, and commercial banking. During the financial crisis and the subsequent economic

 

downturn the bank has come increasingly under pressure to reduce cost and to determine

 

competitive prices. To meet that objective, ABC bank is developing an activity-based cost system for

 

its cashier department which is part of the retail banking division. A task force has identified five

 

different activities: (1) the processing of deposits, (2) the processing of withdrawals, (3) answering

 

customer inquiries, (4) selling negotiable instruments, and (5) the balancing of cash registers. By

 

tracing the costs of operating the cashier department to these five activities, the task force has

 

compiled the following information regarding support costs and activities for one of its branches: Support Activity

 

Processing deposits

 

Processing withdrawals

 

Answering inquiries

 

Selling negotiable instruments

 

Balancing cash registers Estimated Cost

 

£44,445

 

£39,120

 

£37,290

 

£7,290

 

£6,435

 

£134,580 Quantity

 

49,875

 

34,125

 

67,500

 

1,650

 

1,950 The task force has developed the following list of activities which are undertaken in connection with

 

the “Retirement Plus Account”, a current account product marketed to retired persons:

 

Support Activity Average monthly volume per current account Processing deposits 3.5 Processing withdrawals 6.5 Answering inquiries 3.1 Selling negotiable instruments 1.0 Required:

 

a) Calculate the total monthly support costs for the “Retirement Plus Account” product. [4 marks] b) How can the information from the activity-based costing system guide improvements in

 

operations and decisions at ABC Bank? Explain and discuss with reference to the calculations you

 

made above. [8 marks] c) Why should managers worry about product over- or undercosting? Explain and discuss. [4 marks] d) ‘Increasing the number of indirect-cost pools is guaranteed to sizably increase the accuracy of

 

product, service or customer costs.’ Do you agree? Explain and discuss. [4 marks] Your discussion in (c) and (d) should use the case of ABC bank as an illustrative example. Clearly state

 

any assumptions you make. 15

 


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