Absorption and ABC costing system

Assessment criteria:
(i) Calculatefull cost and selling price using Absorption and ABC costing system
(ii) Analysis of full cost and selling price using both costing systems
(iii) Discussion of advantages and disadvantages of both costing systems

For parts 1 & 2, I expect you to use academic references so please ensure you use the Coventry Harvard referencing

system.

Question

Weld plc manufactures mantel clocks. The company makes three different models, A, B, and C. Product costs are

computed on an overhead absorption-rate basis using a labour-hour method. Prices are set based on costs plus 20 per

cent.
The planned figures for next year are as follows:

A   B   C
Material cost (£/unit)   25   62.5   105
Direct labour hours (per unit)   0.5   1   1
Planned production/sales (units)   20,000   1,000   10,000

Next year’s overheads are planned to be £4,410,000. Direct labour is £8/hour.
The company has reduced the selling price of model A, with the result of a very low profit margin. The company’s

finance department has therefore proposed to implement an activity-based costing approach. An analysis of the

overheads led to a grouping of the main business activities into machining (£2,780,000), logistics (£590,000), and

establishment (£1,040,000) costs. These activities can be allocated to the respective cost drivers of machine hours,

material orders and space. This reflects the use of resources in each area. Further investigation showed the proportion of

each model (A, B, and C) of the total volume of products:

A   B   C
%   %   %
Machine hours   40   15   45
Material orders   47   6   47
Space      42   18   40

Required:

1. Calculate for each product the full cost and selling price using:

i) The absorption costing method
(6marks)

ii) The activity-based costing method

(12 marks)

2. Comment on the differences in cost and selling price between the absorption method and the activity-based

cost method
(6 marks)

3. Prepare a report to the board of Weld Plc, explaining the benefits and the shortcomings of the activity-based

costing method and Absorption costing method, and based on your analysis in part (1), provide them with your opinion

on which type of costing should be adopted.
(Marks shall be awarded for appropriate structure and quality of writing)
(26 Marks)

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