COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
COURSE TITLE: COST AND MANAGEMENT ACCOUNTING
INDIVIDUAL ASSIGNMENT
SECTION-4

NAME ID.NO
1. NUHAMIN NADEW----------------------------------------------------------------------------------UGR/
0849/15

SUBMITTED TO: DR. ALEM

SUBMISSION DATE: 1/15/2025
 ADDIS ABABA UNIVERSITY
DEPARTMENT OF ACCOUNTING
COST AND MANAGEMENT ACCOUTING ONE
SELF-CHECK EXERCISE ON ACTIVITY BASED COSTING
PART ONE: MULTIPLE CHOICE QUESTIONS
1) D
2) C
3) D
4) D
5) D
6) D
7) A
8) C
9) C
10) D
11) B
12) C
13) A
14) D
15) C
16) D
17) A
18) B
19) B
20) A
21) D
22) A
23) B
 PART TWO: ESSAY TYPE QUESTIONS
24)
 Activity: An activity is a task or set of tasks performed to produce a product or service,
such as assembling, ordering, or inspecting.
 Cost Driver: A cost driver is a factor that causes a change in the cost of an activity, often
measured by the volume of that activity, such as the number of units produced or the
number of machine hours used.
In summary, an activity is what is done, while a cost driver is what influences the cost of
that activity.

[25)] Here are some common examples of cost drivers used to allocate overhead costs to
products and services:
 Machine Hours: The total hours machines are used in production.
 Labor Hours: The total hours worked by employees in the production process.
 Number of Units Produced: The total quantity of products manufactured.
 Number of Setups: The number of times equipment is set up for production runs.
 Number of Orders: The total number of customer orders processed.
 Square Footage: The amount of space occupied by equipment or inventory.
 Number of Part Types: The variety of different parts or components used in production.
 Inspection Hours: The time spent on quality control and inspections.
 Material Handling: The number of times materials are moved or handled during
production.
 Product Complexity: A measure based on the complexity or variety of products
produced, which may require different resources.
These cost drivers help allocate overhead costs more accurately to reflect the actual
consumption of resources.

25)[26)] Companies commonly use direct labor-hours or direct labor cost to allocate overhead
for the following reasons:
 Correlation with Overhead: Direct labor-hours or costs are often more closely
correlated with the incurrence of overhead costs compared to the number of units
produced. Many overhead costs, such as supervision, maintenance, and utilities,
are more influenced by the amount of labor rather than just the number of units.
 Variability in Production Complexity: The number of units does not account for
variations in production complexity. Different products may require varying
amounts of labor, making direct labor-hours a more accurate measure for
 allocating overhead.
 Capacity Utilization: Using labor-hours reflects how much of the company’s
capacity is utilized. Companies may incur overhead costs based on the time spent
on producing rather than merely counting units, which may not reflect resource
usage accurately.
 Labor-Intensive Processes: In many manufacturing environments, particularly
those that are labor-intensive, labor costs can represent a significant portion of
total costs, making them a reasonable basis for overhead allocation.
 Avoiding Distortions: Allocating overhead based solely on the number of units can
lead to distortions in product costs, especially when production volumes fluctuate.
Labor-based allocation methods can smooth out these fluctuations.
Therefore direct labor-hours or costs provide a more accurate basis for overhead
allocation, reflecting the true resource consumption associated with production activities.

26)[27)] Cost flows using activity-based costing (ABC) differ from those using a single
Plantwide rate in the following ways:
 Cost Allocation Basis:
ABC: Allocates overhead costs based on multiple cost drivers related to specific activities (e.g.,
machine hours, labor hours, number of setups).
Plantwide Rate: Uses a single overhead rate applied uniformly across all products, often based
on direct labor hours or machine hours.
 Accuracy:
ABC: Provides more accurate product costing by reflecting the actual consumption of resources
for each activity, leading to better insights into the costs associated with specific products or
services.
Plantwide Rate: May lead to cost distortions, as it does not account for the variations in resource
usage among different products.
 Complexity:
ABC: More complex to implement and maintain due to the need to identify and measure
multiple activities and their cost drivers.
Plantwide Rate: Simpler and easier to calculate, as it requires only one rate for the entire plant.
 Cost Visibility:
ABC: Enhances visibility into overhead costs by providing detailed insights into specific
activities, enabling better decision-making regarding process improvements and cost control.
Plantwide Rate: Offers less visibility into the specific costs associated with various products,
making it harder to identify areas for improvement.
 Resource Utilization:
 ABC: Helps identify non-value-added activities and inefficiencies, leading to improved resource
allocation and process optimization.
Plantwide Rate: Less effective at identifying inefficiencies, as it aggregates costs without detailed
insights into the activities that drive them.
To wrap up ABC offers a more nuanced and accurate approach to cost allocation compared to a
single plantwide rate, but it comes with increased complexity and resource requirements.

27)[28)] Steps for Implementing Activity-Based Costing:

 Define Activities, Activity Cost Pools, and Activity Measures: Identify and categorize activities
performed in the organization, group them into cost pools, and determine measures to quantify
their usage.

 Trace Costs to Activities and Cost Objects: Assign direct costs to specific activities and trace these
costs to the products or services (cost objects) that consume the activities.

 Assign Costs to Activity Cost Pools: Allocate indirect costs to the defined activity cost pools based
on the identified activities.

 Select Cost Drivers and Calculate Activity Rates: Identify appropriate cost drivers for each
activity cost pool and calculate the activity rates by dividing the total costs in each pool by the total
units of the cost driver.

 Assign Costs to Cost Objects: Apply the calculated activity rates to the actual usage of cost drivers
for each cost object to determine the total overhead cost assigned to each product or service.

28)[29)] Some advantages of using an activity -based costing system?

 Increased Accuracy: More precise allocation of overhead costs based on actual resource use.
 Better Cost Control: Identifies inefficiencies and non-value-added activities for improved
management.
 Enhanced Decision-Making: Provides detailed insights for informed pricing and product mix
decisions.
 Improved Profitability Analysis: Facilitates accurate analysis of product or service
profitability.
 Supports Continuous Improvement: Encourages process optimization and operational
efficiency.
29)[30)] Some disadvantages of using an activity -based costing system

 Complexity: ABC systems can be complicated to implement and maintain due to the need to
identify numerous activities and cost drivers.

 Cost: The setup and ongoing operational costs of an ABC system can be high, requiring
significant resources and time.

 Data Intensive: ABC requires detailed data collection and analysis, which can be burdensome
and may lead to data accuracy issues.

 Resistance to Change: Employees and management may resist transitioning from traditional
costing methods to ABC due to perceived complexity or fear of change.

 Limited Applicability: ABC may not be suitable for all organizations, especially smaller
businesses with less complex operations or those with minimal overhead costs.
 PART THREE: WORKOUT TYPE QUESTIONS
30)[31)]
A)
Cost Pools Activity Activity Rate Spoked Solid
Activity Amount Activity Amount
Machine – setup Setups $180 200 $36,000 800 $144,000
Assembly / Polish Labor hours $4.00 40,000 $160,000 30,000 $120,000
Inspection Inspections $20.00 100 $2,000 1,100 $22,000
Total overhead assigned to each product $198,000 $286,000

B)

Total overhead assigned to each product $198,000 $286,000

Total units produced 10,000 10,000
Overhead cost per unit $19.8 $28.6
31)[32)]
A)
Computation Of Cost & Quoted Price (Using labor hours absorption )
Particulars GC(K) EX(K)
Materials 3,500 8,000
Labor 4,500 7,500
Overheads 3,000 5,000
Total cost 11,000 20,500
Add: Profit (@50%) 5,500 10,250
Quoted Price 16,500 30,750

1. Computation of Overhead Rate:

Overhead rate = Total overheads / Total Labor Hours
= 400,000/40,000
= $ 10 per hour
2. Labor cost :
Labor cost (GC) = 300 hours x $ 1 5 per hour
= $4,500
Labor cost (EX) = 500 hours x $ 1 5 per hour
= $7,500
B) Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the overheads.

Cost pools GC EX
Materials $3,500 $8,000
Labour 300 hrs x $15/hr $4,500
Labor 500 hrs x $15/hr $7,500
Overheads
Supervisor (W2)/(W3) 180 1,080
Planners (W2)/(W3) 280 1,400
Property (W2/W3) 1,800 3,000
To tal cost 10,260 20,980
Quoted price 15,390 31,470

(W2) Costs Number of drivers Cost per driver

Supervisor 90,000 500 180
Planners 70,000 250 280
Property 240,000 40,000 6

W3 Computation of Overheads
Category Total Activit Activit Activity Activit Overhead Overhead
overhea y y rate rate for y rate to GC to EX
d GC for EX
 (B) C= (D) (E) Cx D Cx
(A) A /B E
Supervisor $90,000 500 180 1 6 180 1,080
s
Planners $20,000 250 280 1 5 280 1,400
Property $240,000 40,000 6 300 500 1,800 3,000

C) The pricing policy is a matter for BBB to decide. They could elect to maintain the current 50%
mark-up on cost and if they did the price of the GC would fall by around 7% in line with the costs.
This should make them more competitive in the market.

 They could also reduce the prices by a little less than 7% (say 5%) in order to increase
internal margins a little.
It is possible that the issue lies elsewhere. If the quality of the work or the reputation and reliability of the
builder is questionable then reducing prices is unlikely to improve sales.

 It is conceivable that BBB has a good reputation for EX but not for GC, but more likely
that a poor reputation would affect all products. Equally poor service levels or lack of
flexibility in meeting customer needs may be causing the poor sales performance. These
too will not be ‘corrected’ by merely reducing prices.
It is also possible that the way salesmen discuss or sell their products for the GC is not adequate so that in
some way customers are being put off placing the work with BBB. BBB is in competition and it perhaps
needs to reflect this in its pricing more (by ‘going rate pricing’) and not seek to merely add a mark-up to
its
costs.

 BBB could try to penetrate the market by pricing some jobs cheaply to gain a foothold.
Once this has been done the completed EX or GC could be used to market the business to
new customers.
The price of the EX would also need consideration. There is no indication of problems in the selling of
the EX and so BBB could consider pushing up their prices by around 2% in line with the cost increase.
On the figures in my answer the price goes up for a typical extension to $31,470 from $30,750 a rise of
$720. This does not seem that significant and so might not lose a significant number of sales.

 The reliability and reputation of a builder is probably more important than the price that
they charge for a job and so it is possible that the success rate on job quotes may not be
that price sensitive.
D) Marginal costs are those costs that are incurred as a consequence of the job being undertaken. In this
case they would include only the materials and the labour. If overheads are included then this is
known as total absorption costing.

 Overheads are for many businesses fixed by nature and hence do not vary as the number
of jobs changes. In atraditional sense any attempt to allocate costs to products (by way of
labour hours for example) would be arbitrary with little true meaning being added to the
end result.

 The overhead absorption rate (OAR) is merely an average of these costs (over labour
hours) and is essentially meaningless.

 This switch (to marginal costing) would also avoid the problem of the uncertainty of
budget volume. Budget volume is needed in order to calculate the fixed cost absorption
rate.

 The marginal cost (MC) is more understandable by managers and indeed customers and a
switch away from total absorption cost (TAC) could have benefits in this way.
Clearly if overheads are going to be excluded for the cost allocations then they would still
have to be covered by way of a bigger margin added to the costs. In the end all costs have to
be paid for and covered by the sales in order to show a profit.

 A more modern viewpoint is that activity causes costs to exist. For example, it is the
existence of the need for site visits that gives rise to the need for a supervisor and
therefore, for his costs. If the activities that drive costs are identified, more costs can
then be directly traced to products, hence eradicating the need for arbitrary
apportionment of many overhead costs. This has the benefit of all costs being covered,
rather than the potential shortfall that can arise if marginal cost plus pricing is used.
In the long run businesses have to cover all costs including fixed overheads in order to make a
profit, whichever pricing strategy is adopted.
The pricing policy is a matter for BBB to decide.

They could elect to maintain the current 50% mark-up on cost and if they did, the price of the
GC would fall by around 7% in line with the costs.

This should make them more competitive in the market.

They could also reduce the prices by a little less than 7% (say 5%) in order to increase internal
margins a little.
It is possible that the issue lies elsewhere. If the quality of the work or the reputation and
reliability of the builder is questionable, then reducing prices is unlikely to improve sales.

It is conceivable that BBB has a good reputation for EX but not for GC, but more likely that a
poor reputation would affect all products.

Equally, poor service levels or lack of flexibility in meeting customer needs may be causing
the poor sales performance. These too will not be ‘corrected’ by merely reducing prices.

It is also possible that the way salesmen discuss or sell their products for the GC is not
adequate, so that in some way customers are being put off placing the work with BBB.

BBB is in competition and it perhaps needs to reflect this in its pricing more (by ‘going rate
pricing’) and not seek to merely add a mark-up to its costs.

BBB could try to penetrate the market by pricing some jobs cheaply to gain a foothold. Once
this has been done, the completed EX or GC could be used to market the business to new
customers.

The price of the EX would also need consideration.

There is no indication of problems in the selling of the EX and so BBB could consider pushing
up their prices by around 2% in line with the cost increase.

The answer in part (a) above shows that the price goes up for a typical extension to $31,470
from $30,750 a rise of $720.

This does not seem that significant and so might not lose a significant number of sales.