MANAGERIAL ACCOUNTING II

ACC3023W
ACTIVITY-BASED COSTING

READING REFERENCES
Drury, C. Management and Cost Accounting, 10th Edition, Chapter 11.

MODULE CONTENT
1. Module Objectives
2. SAICA Competency Level
3. Definitions
4. Class Notes
5. Lecture Example
6. Tutorials

TUTORIALS

Week1 Week 2
AB01: QualityTables (Pty) Ltd AB04: Umzobo (Pty) Ltd
AB02: Theron (Pty) Ltd AB05:UniversalCampusofTechnology(UCT)
AB03: DuoMake (Pty) Ltd * AB06:Phony (Pty) Ltd *

* Unseen tutorial to be prepared

MODULE OBJECTIVES

On completion of the lectures and relevant set work the student should be able to:

1. Describe the differences between activity-based and traditional costing systems;

2. Explain why a traditional costing system may provide misleading information for decision making;
3. Explain each of the four stages involved in designing ABC systems;
4. Understand ABC cost management applications;
5. Identifydifferenttypesof costsandtheirbehavioursbased onaparticulardriver;
6. Identify an appropriate cost driver;
7. Understand and be able to explain the difference between a volume driven and non-volume driven
indirectcost;
8. Be able to cost a product from a traditional costing and ABC perspective.

SAICA COMPETENCY LEVEL

Costing and cost management: Overheads Knowledge

Level

Recording overhead costs

3
Is requiredasbaseknowledge for otherareas– will not bespecificallyexamined.

Bases of assigning overheads to cost objects

3
o Absorption vs variable costing
o Traditional volume-based measures
o Activity-based costing and cost drivers

Product or service costing

Types of costingsystems
3
o Job costing (batch costing)
o Process costing systems

Isrequiredasbaseknowledgeforotherareas – willnotbespecificallyexamined. Emphasisshould

beplacedontheprincipalofequivalentunitsand theimpactof spoilage on productcosts.

Information technology implications (integration) 1

DEFINITIONS

Activities: The aggregation of many different tasks, events or units of work that causes the consumption of
resources.
Activity Cost Drivers: A cost driver used to assign the costs assigned to an activity cost centre to products.
Activity Cost Centre: A cost centre in which costs are accumulated by activities.
Activity-Based Costing (ABC): A system of cost allocation that aims to use mainly cause-and- effect cost
allocations by assigning costs to activities.
Activity-Based Management (ABM): The cost management applications applied to activity- based costing,
without the need to assign activity costs to products, also known as activity- based cost management.
Batch -Related Activities: Activities that are performed each time a batch of goods is produced.
Cost Driver: The basis used to allocate costs to cost objects in an ABC system.
Cost of Resources Supplied: The cost of resources supplied for an activity, whether or not all these resources
are actually required, which may include the cost of some unused capacity.
Cost of Resources Used: The cost of resources actually used for an activity, which excludes the cost of any
unused capacity.
Cost of Unused Capacity: The difference between the cost of resources supplied and the cost of resources
used.
Duration Drivers: A cost driver used to assign the costs assigned to an activity cost centre to products that is
based on the amount of time required to perform an activity.
Facility Sustaining Costs: Common costs that are incurred to support the organization as a whole and which
are normally not affected by a decision that is to be taken.
Facility Sustaining Activities: Activities performed to support the organization as a whole, also known as
business sustaining activities.
Indirect Costs: Costs that cannot be identified specifically and exclusively with a given cost object, also known
as overheads.
Non-Volume-Based Cost Drivers: A method of allocating indirect costs to cost objects that uses alternative
measures instead of assuming that a product's consumption of overhead resources is directly related to the
number of units produced.
Product Sustaining Activities: Support activities that are performed to enable the production and sale of
individual products and which are not related to the volume of each product.
Transaction Drivers: A cost driver used to assign the costs assigned to an activity cost centre to products that
is based on the number of times an activity is performed.
Unit-Level Activities: Activities that are performed each time a unit of the product or service is produced.
Volume-Based Cost Drivers: A method of allocating indirect costs to cost objects that correlates a product's
consumption of overhead resources with the number of units produced.

Source: Drury 10th Edition.

CLASS NOTES

TRADITIONAL COSTING METHOD:

- Allocation of onlymanufacturingoverheads, notnon-manufacturingoverheads

- Allocation via one of two simple methods:
o Volumes (Labour hours, number of units (if products homogenous), machine hours, etc.)
o Value (% of Sales Price)
- Simple cost allocation method but adequate and useful if four indications for ABC not fulfilled (see
below).
- Useful where the product range is simple and there is a cause & effect relationship between allocation
basis and costs.
- Why waste extra money on implementing a complicated method (such as ABC) when this will provide
equally useful information for decision making and cost control?
- If overhead costs do not have a direct relationship, so how to allocate?

ACTIVITY BASED COSTING:

Indications that ABC may appropriate to utilise in an organisation:

- Competitiveness of Industry(High)
- Diversity / Complexity of Products (High)
- Profit Margins (Low)
- Significance of indirect costs as % of totalcosts, andinabsoluteterms (High)

The overall objectives of ABC are:

- Allocating indirect costs (both manufacturing and non-manufacturing) in line with cost causation.
- Direct costs = Traced directly to the product; Indirect Costs = Allocated to product as not able to be
traced directly.
- Improved decision making and cost control.

Which costs are subject to ABC principles:

- Overridingprinciple: Relevance.
- Applying the principle: Categories of costs
- Fixed & variablecosts
- Manufacturing & non-manufacturing overheads
- Direct or indirect?
- 4 Types of Cost Levels (Useful for pooling of costs):
o Unit-level
o Batch-level
o Product-level
o Facility Sustaining

Cost drivers:
- Accuracy of allocation
- Cause and effect
- Plausible relationship
 - 3 Types of Drivers (Activities):
o Transaction based (Number of times activity is performed)
o Duration based (Length of time activity is performed)
o Intensity Based (How difficult/complex activity is)
- Fixed cost: Rate is determined based on practicalcapacity.
- Variable costs: Matching – Actual usage.

Rationale for ABC:

ABC/M is tool that can be useful for:

1. Improved decisionmaking: by providing reasonably accurate information with regards to the consumption of
overheads by products and services; and
2. Cost reduction and control: ABC/M can be used to encourage greater efficiency in resourceconsumption, so
supporting cost controlwithin an organisation.

1. Decision Making:
ABCis necessary forcorrectdecision makingincertaincircumstances, dueto twofactors:

a. The diversity of product range. Different products will usually not consume resources homogenously. Not all
indirectcostsareunitlevel(i.e. varydirectlywiththevolume ofunitsproduced).Thecomplexityoftheproduct,
as wellas batchsizes(assomecosts arebatch level), and thesize of theproductrange (as some costsare incurred
in order to sustain the product range) all impact how resources are consumed.

As a result, the typical finding when products are costed using ABC for the first time, is that under the
traditional approach:
o High volume or less complex products were over-costed; and
o Low volume or complex products were under-costed.

b. The significance of indirect costs. Indirect costs are significant in absolute terms, as well as relative to
direct costs. I.e. the impact of inaccurately allocating indirect costs is significant that it would may alter
decisions.

2. Cost Control:
By controlling cost drivers (the activities that cause costs to be incurred), the indirect costs can be controlled.
Effectively, costs that were previously considered to be non-traceable and, in volume terms, non-controllable,
are effectively turned into traceable costs, much of which is variable to some extent (and thus relevant to
decision making) in the long-term.

Issues and considerations regarding ABC:

1. ABC can be very expensive. The cost/benefit of implementing ABC does not exist in every case (i.e. the
cost of implementing and operating the ABC system outweighs the financial benefit of improved decision
making or control). This would be the case where the distortion in cost allocation created by a simpler
system is not significant, either because resources are consumed homogenously or because the
organisation is not overhead intensive and overheads are not significant from both an absolute and
relative perspective.

2. The reliability and accuracy of the cost information generated by an ABC system is undermined by
impracticalities:
o The cost information is only as accurate as the accuracy with which the cost drivers have been
identified. Many costs have multiple cost drivers, relating to both volume, time and intensity of
use – therefore it is difficult to allocate;
o Common errors include the mismatch of cost information to usage of activity, due to cut off
problems;
o Notice should be taken of any changes in technology or methodology during the period under
review, asthismayaffectthecost-causationrelationship;
o The cost information is only as accurate as the information that has been entered;
 o The allocation of facility level costs may be as arbitrary under ABC as it is under any other method.

3. ABC can create a false impression of the relevance of overheads costs to decision making. The timeframe
and scope of the decision must always be considered:
o The impression can be created that overhead costs are variable in the short term when in fact they
are actually either fixed or step fixed costs that will not be affected by a small change in the cost
driver.
o Some costs are variable in the short term – and while other costs may be fixed in the short term
most costs are variable in the long term. Stepped fixed costs can also be saved in the short term,
hence making them relevant; provided that the organisation is aware of the step down and takes
action on the information. In many enterprises ABC is perhaps more suited to long term decision
making rather than short term decision making.
o The greatest potential for cost management exists where ABC information is used at the strategic
level (i.e. decisions regarding the company’s overall product range and business model), as at this
level the greatest scope exists to manage and alter the resource requirements of an enterprise.

Financial reporting:
IAS2 has the following requirements with regard to overheads:
- Overheads (to the extent that they are costs of production) are regarded as conversions costs.
- Overheads should beallocated to inventories on a systematic basis (para 12);
- The allocation of fixed production overheads is based on the normal capacity of production facilities
(para 13):
- Normal capacity is the production expected to be achieved on average over a number of periods or seasons
under normal circumstances;
- Normal capacity takes into account planned maintenance;
- Actual level of production may be used if it approximates normal capacity;
- Variable production overheads are allocated to each unit of production on the basis of the actual use of
the production facilities
- Unallocated overheads are recognised as an expense in the period in which they are incurred

Budgeted Rates vs. Actual Rates, and Under/Over-Allocation:

Use budgeted rates rather than actual rates in practice.

Reasons supporting a predetermined overhead rate are:

- Timeliness:Therequirement oftimeliness overrides therequirement ofaccuracy.
- Cost Fluctuations: Avoid fluctuations in cost due to fluctuations in activity, for both managerial and
financial accounting purposes. The argument from a managerial accounting perspective is that
management is committed to costs in the long term, thus an average annualised rate better reflects the
relationship between cost and volume, rather than a monthly rate which fluctuates.
- Correction possible: The accounting recordswillnot be misstated dueto theuseof budgeted rates, as these
can be “corrected” for actual costs and volumes by dealing with under/over-absorptions as appropriate. As
a general rule:

o Under-absorptionsresultingfrom inefficiency (usually)arenotinventoriable

{close variance to Cost of Sales (IAS2:13)}.

o Over-absorptions result in inventory being stated above historic cost {not permissible in IAS2 –
Inventory is to be recorded at the lower of actual cost or NRV} and the over absorption should be
removed from inventory. Pro-ration is required to determine the amount of the variance to be
removed from inventory.

- Control is encouraged: Variances arising as a result of differences between budgeted and actual figures
give rise to the opportunity for investigation; and either better planning or control in the future.
LECTURE EXAMPLE 1

Feel Right (Pty) Ltd manufactures three types of fabrics that it sells to large name-brand clothing companies and
retailers throughout South Africa. The company operates from its factory in Lower Woodstock, Cape Town.

The level of competition in the textile industry has increased significantly over the last few years, especially from
international sources. Much of this is due to the incredibly cheap labour in the textile industry in China. In addition, due
to the recession, people in general are not buying clothing as frequently and prefer to spend less on luxury goods. As a
result, Feel Right is close to bankruptcy and has made a significant loss this past year. The managing director, Shifty Left
Eye, has been comparing the profit margins of the different textiles that the companysells, to identifywhetherthe
companyis carryingloss-makingproducts, as generally speaking a company would want to discontinuethese products and
focus on marketing more profitable lines.

Shifty is not confident about the current costing methods, although neither he nor his financial director actually
understands why they feel uneasy. In fact, he is convinced that the costing is at best slightly inaccurate, but may be very
inaccurate. As a result, Shifty has asked you, a budding and upcoming independent financial advisor from Resenture Ltd
consulting, to assist with solving this dilemma. In order to understand the situation better, as well as how severe the
problem might be, you have interviewed the staff and Shifty and obtained certain financial information.

The financial results for the 2009 year for Feel Right (Pty) Ltd are as follows:

EXHIBIT A (Income statement for Feel Right (Pty) Ltd for the 2009 financial year)
R's % of revenue

Revenue 10 000 000 100%

Direct Costs (3 300 000) -33%
Manufacturing Overheads: (4 650 000) -46.50%
Labour (1 400 000)
Maintenance (1 450 000)
Electricity and water (1 000 000)
Rent (800 000)
Gross profit (net direct selling costs included in direct costs above) 2 050 000 20.50%

Non-manufacturing Overheads: (2 700 000) -27%

General Admin Expenses (300 000)
Advertising for the Company as a whole (1 500 000)
Advertising for Specific Products (900 000)
Net Loss (650 000) -6.50%

Feel Right produces three different types of fabrics. The first fabric is a finely woven material used in making
quality pashminas, and jerseys, called Woollen Fabric. The second type of material produced by finely spun
thinstrandsilkfabric called Silky Smoothisused for very expensivesilk ties and the odd bright red Matador
shirt (Bull fighters in Spain usually wear these). The final type of fabric, called Just Plain is a regular cotton
material but once again, of ahigh quality, whichbrand-namecompanies such as Red Hardy like to use in their t-
shirtsand tops. The Revenue for each of the three products, per kg of fabric, is as follows:

Woollen Fabric Silky Smooth Just Plain

Revenue 165 680 150
(R’s/kg)
 Feel Right has various activities involved in the production process but with the help of an advisor, the
activities have been classified into four main types.

1. Set-Up and Quality Assurance: This relates to examining products for defaults, where a selected number of
items are tested per batch, and setting up the machines for pressing the various strands of fabric.

2. Pressing: This is where a machine press is used to iron the fabrics flat and allow multiple layers to be
pressed together.

3. Storage:This relates to how much space the production of that specific fabric takes up in the factory. For
example, Silky Smooth requires a lot more space for machinery yet requires only minimal space for
storage.

4. Marketing: This relates to which type of fabric is being produced but essentially, there are 3 categories.
Namely:
a. Very Difficult (2x Factor)
b. Standard (1x Factor)
c. Very Easy (0.5x Factor)

These categories relate to how complex the product is to market to buyers. Certain fabrics sell by virtue of their
quality, while others require active marketing techniques.

Shown below are various exhibits giving information obtained from the client pertaining to the activities/rates, cost
drivers and other useful information. The numbers may be assumed to be correct. However, the choice of cost driver
may be incorrect.

EXIHIBIT B (Cost Drivers)

Type of Cost Activity Cost Driver
Manufacturing Overheads:

Labour Variable Set-up and Quality Batches

Assurance
Maintenance Fixed Pressing Machine Hours
Electricity and Water Variable Pressing Machine Hours
Rent Fixed Storage Square Meters
Non-manufacturing
Overheads:
General Admin Expenses Fixed Marketing Category of Product*
Advertising for Feel Right for Fixed Marketing Category of
the Company as a whole Product*
Advertising for Specific Category of
Fixed Marketing
Products Product*
*i.e.verydifficult,standard, orveryeasy
EXHIBIT C (Activities)

Product Woollen Fabric Silky Smooth Just Plain

Number of kg’s Produced 25 000 3 125 18 750

Activity
Batch Sizes 20 kg 5 kg 30 kg
Square Meters 3 000 2 000 4 000
Category of Product Very Difficult Very Easy Standard
Machine Hours per Batch 5 5 5

EXHIBIT D (Capacities)
Practical Normal Capacity Actual Capacity
Capacity
Machine Hours 15 000 12 500 12 500
Batches 3 000 2 500 2 500
Square Meters 10 000 9 000 9 000

Required:

1) Compute the indirect cost allocation per kg for products Silky Smooth and Just Plain, based on a traditional
costing system where overheads are allocated based on machine hours at normal capacity. (5 marks)
2) Is ABC appropriate for this business? Include specific evidence from the question to support your answer. (7
marks)
3) Compute the indirect cost allocation per kg for products Silky Smooth and Just Plain based on ABC principles. (13
marks)
4) Compare the results of your computation in 1 and 3. Discuss what course of action the company should take
based on these computations. (5 marks)

to protect human health and safety from food products.

1
 LECTURE EXAMPLE 2 (15 Marks)

Lulu Chickens (Pty) Ltd (hereafter referred to as “Lulu” or the “Company”) is a poultry-rearing1 company located in the
farmlands of the Western Cape. The company was incorporated by Lulu in 2019 after failing to find employment post
her degree in agriculture. Due to that disheartening unemployment experience, Lulu is committed to reducing
unemployment by employing locals in the company.

Lulu is passionate about healthy living and is dedicated to rearing organically and humanely raised chickens to the tables
of her consumers. Growth hormones have been linked to adverse health effects in humans and Lulu strives to rear
chickens as naturally as possible.

Lulu purchases day old broiler chicks2 from a local breeder and rears the chicks in a free-range environment3 inside large
barn structures. Lulu requires the chicks to have at least 0.2 square meters of space in order to allow them to roam
freely and happily. The required space per chick does not increase as the chicks grow into chickens. Lulu targets the
organic market that appreciates higher quality and a more deep and pleasant flavour of chicken arising from the healthy
rearing process.

Day old chicks are also very sensitive in their early stages and require consistent warmth due to the feathers not having
grown out yet. As a result Lulu is required to use a heat lamp during the first 6 weeks of a chicken’s life in order to
provide sufficient warmth amongst the chicks at night. After 6 weeks, chickens 4 can fully maintain the heat on their own
that they require for optimal growth.

Lulu employs amazing chicken champions5 on a full-time basis, to make sure the chickens have enough food, water, and
lighting to encourage optimal growth of the chickens. These employees reside in nearby rural areas where job
opportunities are scarce. Once ready for harvest at 16 weeks with a body weight of 2kg, the chickens are either sold as live
chickens at the barn or barbeque flavour fresh chicken to organic stores. This 16 week period is known as the rearing
cycle and is the duration of growing a chicken from day-old chick into a fully grown chicken.

To maintain the highest quality standard, Lulu has appointed an internal food quality professional to inspect that every
chicken is of an appropriate standard and complies with poultry standards and health regulations. The approval of the
inspector is vital, as only food items complying with the National Regulator for Compulsory Specifications 6 can be sold in
the country. There are either two or three inspections that happen (depending on the type of product being sold).

Chickens are all inspected at week 6 to ensure the chickens are healthy and reared in a clean environment. Once ready
for harvest a secondary check is performed on all chickens to confirm grade status and certify that chickens are safe for
human consumption. The last inspection is conducted during the marinating and packaging stage for the barbeque
offering only.

The barbeque flavoured chicken is coated in Lulu’s family secret barbeque marinade. Lulu’s family registered a patent
over this unique marinade 15 years ago but had not commercially exploited the use thereof. Lulu had previously only
sold live and plain fresh chicken until she had the idea to experiment with adding the barbeque marinade to the plain
fresh chicken offering. The barbeque chicken offering became a hit and soon thereafter

1
Bring up or care for the chicks until they become full grown chickens.
2
Newly born chicks usually one day old.
3
Environment where chickens have access to food, water, sunshine, shade, ability to roam freely and the prohibited use
of growth hormones.
4
After 6 weeks, chicks have grown into bigger birds termed chickens.
5
Employee responsible for rearing chicks into chickens
6
Entity of the Department of Trade and Industry established to administer compulsory specifications with the mandate

to protect human health and safety from food products.

1
 the plain chicken offering was phased out.

Lulu has drawn up the following budget for the first rearing cycle of the 2021 financial year and is very worried about the
projected loss. Lulu is considering the import of barbeque chickens from United States (see later) and requires your help
to determine the offer price to the supplier.

Table 1

Description Note Cost

Revenue 1 3 750 000
Day-old chick 2 (562 500)
Feed 3 (1 350 000)
Medicine 4 (56 250)
Water and electricity 5 (91 500)
Chicken champion labour 6 (96 000)
Depreciation 7 (1 496 250)
Inspection 8 (40 000)
Cull, clean, flavour and packaging 9 (40 000)
Rent 10 (48 000)
Net Profit /(loss) (30 500)

1. Revenue
Lulu on average sells 2 live chickens for every 4 barbeque flavoured chickens. Each live and barbeque flavoured chicken is
sold for R90 and R105, respectively. The budget is based on the current total demand of 37 500 chickens per rearing
cycle.
2. Day old chicks
At the beginning of each rearing cycle, Lulu concludes a single purchase of day-old chicks from a local chicken breeder.
The local breeder charges R15 for each day-old chick and offers delivery services to the customer’s barns. The local
chicken breeder can transport 25 000-day-old-chicks per single trip.

Customers get free delivery for single purchases exceeding 20 000 day-old-chicks. To discourage purchases of smaller
quantities a fixed delivery fee of R20 000 is charged per trip, for single purchases below 20 000 day- old-chicks. Lulu does
not have a suitable delivery vehicle that can transport the chicks safely and will rely on the delivery service of the local
chicken breeder.

3. Feed
Lulu’s chickens ordinarily need to eat 2.5kg of chicken feed for it to translate into an additional 1kg weight to the chicken
(i.e. for every 2.5kg of chicken feed eaten, the chicken puts on 1kg of weight). Lulu is able to purchase a 10kg bag of feed
for R80 at the farmlands market. Each day-old chick weighs 0.2kg when it arrives at the farm. At the end of the 16 week
rearing period when chickens are ready for harvest, chickens on average weigh 2kg.
4. Medicine
Medicines are mixed into the drinking water of the chickens over their 16-week lifecycle and each chicken is estimated
to consume about R1.50 worth of medication in total over the 16-week period.

5. Water and electricity

Lulu received the below invoice for her past three rearing cycles and was notified by the municipality that there was an
additional 10% charged on the fixed levy for rearing chickens of more than 30,000 (i.e. the additional

2
 levy kicks in when you rear 30,001 chickens).

Cycle Number of chickens Cost

Cycle 1 25 000 65,000
Cycle 2 30 000 75,000
Cycle 3 40 000 96,500

6. Labour
Lulu employs 6 chicken champions to administer medicine, feed and ensure the overall good health of the chickens.
Chicken champions receive a weekly wage of R1 000 each. Chicken champions normally work 42 hours every week even
though they have sufficient capacity to work 52 hours weekly. The actual hours spent amount to 1 344 for live chickens
and 2 688 for BBQ chickens.
7. Depreciation
Lulu uses one heat lamp per group of 50 chicks to ensure that there is sufficient warmth amongst the chicks at night.
During the first week the chicks need 12 hours of daily heating and this is normally reduced by 1 hour per week until the
end of week 6 when the lamp is switched off. Practically Lulu can keep heat lamps on for 12 hours per day for the full six
weeks.

The depreciation amount in the table is based on using 750 lamps to meet the expected demand. Each heat lamp costs
R60,000 and has a capacity to function for 12 000 hours. Depreciation is allocated on a per hour basis. Each heating lamp
is used for approximately 399 heating hours per rearing cycle.

8. Inspection
At each point of inspection (see earlier for detail on frequency of inspections for the different products), the inspector
marks each chicken or packaging with a marker to illustrate the chicken has been checked to be following the required
standards. Inspections at all inspection points use the same amount of time and the inspector can perform 100 000
inspections over the rearing cycle. The inspector receives a monthly salary of R10,000.
9. Culling, cleaning, marinating and packaging
Lulu firmly believes in uplifting the community by providing job opportunities to the youth in the area. Lulu entered into
an agreement with Chickie Youth7 to cull8 , clean, marinate and package their BBQ chickens for sale at organic stores.
Lulu is the only client of Chickie Youth.

Chickie Youth collect the chickens from the barn at end of each rearing cycle to render their services at their premises
and can work for 12 500 hours per rearing cycle. This is a very manually intensive exercise with each chicken normally
taking 15 minutes to clean and cull. Marinating and packaging take an additional 10 minutes and 5 minutes per chicken
respectively. The normal capacity of Chickie Youth is 10 000 hours. Chickie Youth receive a fixed payment for their
service at the end of each rearing cycle.
10. Rent

Lulu rents an 8 000 square meter barn for R12,000 per month. Most of the space is used for chicken rearing and only 150
square meters is used as a small office and tearoom for the chicken champions.

Lulu adopted a traditional absorption costing system to allocate overheads based on Chicken Champions labour hours. Lulu
wants to obtain accurate information about the true cost of chicken offerings, to apply a mark-up thereon and improve
profits. Lulu heard about activity-based costing (ABC) system at a finance workshop and

7
Company started by local youth in the area to provide chicken culling, cleaning and marinating services.
8
Humanely kill the chicken.

3
 is considering implementing it at the company. Lulu is unsure about the technical details and will require your help, as
the management accounting expert, on the ABC costing schedule prepared by Lulu in table 2.

Table 2 : ABC Costing Schedule

Live
Activity Barbeque Barbeque Live chicken
rate Chicken Chicken cost chicken cost
Cost Activity (3)= Usage allocated usage allocated Total cost
Type of cost (1) Cost driver (2) (1)/(2) (4) (5)=(3)x(4) (6) (7)=(3)x(6) (8)=(5)+(7)
Number of
Water and chickens
Electricity 91,500 reared 37,500 2.44 25,000 61,000 12,500 30,500 91,500
Chicken
champion labour 96,000 Labour hours 4,032 23.81 2,688 64,000 1,344 32,000 96,000

Depreciation 1,496,250 Heating hours 378 000 3.96 189 000 748,125 4 500 000 189 000 1,496,250
Number of
Rent 48,000 m2 7,500 6.40 5,000 32,000 2,500 16,000 48,000
Clean, Cull,
marinating and
packaging costs 40,000 Labour hours 12,500 3.20 12,500 40,000 - - 40,000

Total cost 945,125 826,625 1,771,750

Number of units 25 000 12 500 37 500

Cost per unit 37.81 66.13

Importing barbeque marinated chicken

Lulu is considering importing barbeque marinated processed chickens from the United States. Lulu is concerned about
profitability and heard that American chickens are much cheaper and is of the view that will improve her profitability. If
Lulu goes ahead with importing the BBQ chicken, she will only rear chickens that will be sold as live offerings. Lulu will
ship the famous barbeque marinade to the supplier and has negotiated unlimited shipping of this marinade to the
United States for R21,000 every 4 months (i.e. per rearing cycle). This will therefore enable Lulu to import the chickens
already coated in Lulu’s secret barbeque sauce. The chickens will be much bigger in size due to the use of steroids and
hormones to promote rapid growth.

The chicken rearing process will take only two weeks for these chickens to fully grow and will on average weigh 3kg each
when fully developed. Due to this quicker rearing process, the supplier has unlimited supply of chickens available and is
always looking for an opportunity to partner with new customers.

Lulu came across #NoToChickenCruelty, Twitter trend, alleging that the American supplier is rearing chickens in a cruel
way. Images and videos of chickens housed in tiny cages, with questionable hygiene and culled in an inhumane manner
were circulating. This has caused an outcry with animal activists protesting against animal cruelty. The supplier already
supplies existing supermarkets in SA and there has been talks of protesting at the supermarkets affiliated with the
American supplier.

Additional Information
• You should assume the mathematical accuracy of table 1 and 2.
• You should assume that none of the chickens die during the rearing period.
• You should assume each month has 4 weeks.

4
• You should assume that the ‘Cost’ presented in Table 2 (i.e. the second column) is correct.
• Round off all workings to 2 decimal places.

REQUIRED MARKS
2. Prepare a memorandum to Lulu that: identifies, explains, and corrects any 14
errors or omissions made in preparing the Activity-Based Costing calculation in
Table 2. Only necessary calculations to support corrections are required (i.e.
you do not have to recalculate the entire cost allocation and can assume your
corrected calculated amount was used for the remainder of the cost allocation).
Ignore the chicken importing option for this question.

Use the following table in your memorandum:

Number of Error and Identified error Explanation and
Activity Correction of error
e.g. 1 - Overall e.g. Management e.g. When using a
allocated fixed variable costing
(This is an illustrative manufacturing system, all fixed costs
example not related to overheads to the cost are treated as a period
the ABC calculation, of the inventory when cost and are not
only for demonstration the company use a allocated to the cost of
purposes) variable costing inventory.
system.

Layout, workings clarity, and structure 1

TOTAL 15

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 MANAGERIAL ACCOUNTING II
ACC3023W
ACTIVITY-BASED COSTING
TUTORIAL QUESTIONS

TUTORIALS

Week1 Week 2
AB01: QualityTables (Pty) Ltd AB04: Umzobo (Pty) Ltd
AB02: Theron (Pty) Ltd AB05:UniversalCampusofTechnology(UCT)
AB03: DuoMake (Pty) Ltd * AB06:Phony (Pty) Ltd *

* Unseen tutorial to be prepared

6
 AB01: (QualityTables) (30 Marks: 36 Minutes)

QualityTables (Pty) Ltd (“QualityTables”) is a manufacturer and retailer of premium tables. QualityTables
is a boutique store located in Cape Town, and only produces two models of tables. The store is experiencing
a challenging financial year due to the tough economic environment and the increase in competition within
the sector.

QualityTables currently utilises a traditional absorption costing system to allocate overheads based on
direct labour hours. The company is considering implementing an activity based costing (ABC) system for
the two tables produced. The ABC analysis will focus on the two tables – the Classic (which comprises
straight stylish lined finishing) and the African (which comprises detailed engravings on the table’s edges).

The following information has been obtained with regards to each product:

Caption Note Classic African

Selling price per unit 14 000 18 800
Direct material per unit 1 7 500 9 000
Direct labour cost per unit 2 2 500 4 000
Number of tables manufactured/sold per annum 800 500
Direct labour hours per unit 25 40
Machine hours per unit 3 5 10
Number of tables per batch 4 5 5

Notes:

1. Direct materials consist primarily of the high-quality wood, however there are other materials such as steel
supports, hinges, and glue to reinforce the table structure.
2. Labourers are charged at R100 per hour
3. The wood needs to be cut to size prior to being hand crafted and shaped. A machine is also utilised to
finish off the tables with a polyurethane layer that seals the grain for protection against heat and liquid
damage. The African table requires more machine hours due to the additional engraving requirements.
4. The number of batches relate only to the transportation of the tables for delivery. The batches for both the
Classic and African table are transported in batches of 5.

The overhead costs for the period amounted to R4 400 000. The overhead costs (which are the activities)
were driven by the following activity cost drivers.

Overhead Cost Note Amount Cost Driver Cost Behaviour Cost Nature

Equipment depreciation 3 800 000 Machine hours Fixed Manufacturing

Electricity 1 000 000 Machine hours Variable Manufacturing
Quality control 1 000 000 Per unit Variable Manufacturing
Transport 4 400 000 Number of batches Variable Non-manufacturing
Rent 5 1 200 000 Metres Squared Fixed Non-manufacturing
Total 4 400 000

7
5. Of the rental cost, R200 000 relates specifically to the African table additional storage
required, this space can be sublet as necessary. QualityTables is not able to alter the
size of the remaining rental space as they have entered into a long-term lease
agreement with the landlords.

The cost drivers and the associated activity levels have been identified as follows:

Cost driver Note Budgeted Activity Actual Activity Practical Activity

Machine hours 3 9 500 9 000 10 000
Number of units 1 400 1 300 1 400
Number of batches 4 280 260 300
Metres squared 5 1 400 1 500 1 600
Number of labour hours 42 000 40 000 44 000
Actual activity is based on the number of units manufactured/sold

Additional information:

- QualityTables wishes to maintain a total cost plus mark-up of 20% for its products.

Required:
1. Calculate the profit per unit for the Classic and African Table under the traditional
method. Round off solution to the nearest Rand. (6 Marks)
2. Calculate the profit per unit for the Classic and African Table in terms of ABC principles.
Round off solution (not activity rates) to the nearest Rand. (16 Marks)
3. Critically evaluate the costing system (traditional system) utilised by QualityTables with
specific commentary on:
o Reason for the differences in calculation 1 and calculation 2
o Whether ABC is appropriate for QualityTables
o Other valid points for consideration (6 Marks)

Professional communication and layout (2 Marks)

8
 AB02 Theron (Source: SUPP 2010) (39 Marks)

Theron (Pty) Ltd is a relatively new company located in the Western Cape producing soccer boots. Theron
is eager to take advantage of all the excitement surrounding the 2010 Soccer World Cup in South Africa.

Theron has two boot brands, namely Boooth © and Beckham©. Boooth© is a relatively cheap boot, made
locally, but ideally suited for the current global economic situation. The Beckham© is a designer brand with
David Beckham’s autograph stitched into the boot leather as well as a special “swerving groove” moulded
into the boot. The Beckham© is part of Theron’s “Bend it like Beckham” campaign.

After the successful World Cup Draw in Cape Town, Theron is eager to establish which of the two boots to
emphasize to ensure Theron can maximize profits in the build up to the Soccer World Cup. However,
Theron’s management is concerned that the margins earned on Boooth© boots are low and may even be
negative, thus detracting from profits. Therefore, despite Boooth © being ideally suited to the current
economic situation, management are considering dropping this line.

Table 1 below shows a breakdown of the profit and loss for the two boot brands for the 2009 financial year.

Table 1 Note Shoe Type

Boooth © Beckham © Total
Number of Pairs Sold (normal capacity) Price per Pair 10,000 5,000
of Shoes R540 R900

Revenue 5,400,000 4,500,000 9,900,000

Total Costs 6,000,000 3,500,000 9,500,000

-Direct Costs N1 1,000,000 1,000,000 2,000,000
-Overhead Cost 7,500,000
-Manufacturing overhead costs N2 4,200,000 2,100,000 6,300,000
-Non-manufacturing overhead costs N3 1,200,000
Net Profit (excl. interest and tax) 400,000

N1: Raw materials are the only direct cost in the business. As the Beckham boots require special material and
stitches, the per unit raw materials cost are double that of a Boooth unit.

N2: Manufacturing overheads consist of the following:

Table 2 Notes
Factory rental 2,000,000
Factory insurance 30,000
Stitching related overheads 2,500,000
Packaging related overheads 1,370,000
Machine set up related overheads 400,000
Total: 6,300,000

All the above manufacturing overhead costs cannot be changed in the short term and can be regarded as
fixed in nature.

9
N3: Non-Manufacturing overheads consist of the following:

Table 3 Notes

Advertising 900,000

Advertising (General) N4 300,000

Total: 1,200,000

The above non-manufacturing overheads can be changed in the short term and can
be regarded as variable in nature.

N4: General advertising is considered to be advertising for the company as awhole.

The company currently uses the number of units produced, based on normal capacity to
allocate manufacturing overheads as per IAS 2. Non-manufacturing overheads are treated
as period costs and written off in the income statement.

Management have expressed the concern that the product costs may not be meaningful.
They have heard of a costing system called Activity Based Costing (ABC) and have
approached you, as a management accounting consultant, to establish whether ABC should
be implemented at Theron.

You have done some preliminary interviews with staff at Theron and have established the
main activities being performed. You have also established that many of the activities are
driven by cost drivers that are not volume related.

Table 4 Annual usage of cost Total Capacities

driver
Activity Cost Driver Boooth Beckham Normal Practical
Stitching Number of
stitching hours 2,000 2,500 4,500 5,000

Packaging Number of
boxes 1,000 500 1,500 2,000

Machine set up Number of

batches 1,000 1,000 2,000 2,000

TV & Magazine Complexity to

ads Advertise 0.5 1.5 2 2

10
REQUIRED:

1. Implementing an ABC system is a costly exercise, both in human and capital resources. Discuss
the characteristics of Theron that would support or not support the implementation of an ABC
system to assist with decisions regarding product mix.
(4 marks)

2. The traditional (conventional) product costing system, in terms of IAS2, assigns manufacturing
overheads to products based on normal capacity. Explain how a fully implemented ABC system
differs from the traditional approach to product costing.
(8 marks)

3. Explain why in an ABC system costs that cannot be changed in the short term (fixed costs) are
allocated based on the practical capacity of the cost driver, while costs that can be changed in
the short term (variable costs) are allocated based on actual usage.
(2 marks)

4. Compute the gross profit per unit of Boooth© and Beckham© using the traditional costing
system. (4 marks)
5. Calculate the gross profit per unit of Boooth© and Beckham© based on ABC
(18 marks)
6. Compare your traditional versus ABC cost computations. Explain the reasons for the difference
(or similarity) in the results. What action should Theron take concerning the product mix?
(3 Marks)

11
AB03: DuoMake (UNSEEN*) (Source: ACC2022) (40 Marks: 51 Minutes)

DuoMake Pty Ltd (DuoMake or Company) operates two retail stores in Johannesburg South Africa. The Company
specialises in high-end female fashion garments. The Company is a new start-up venture, as a result it has a
limited range and only produces two dresses currently. DuoMake has distinguished itself as fashion producer
that is environmentally conscious, as the Company utilises recycled fabric in order to manufacture one of its
garments. The current trends within the fashion industry is towards environmentally conscious products.

The tough operating economic environment in South Africa due to the recession and low GDP growth, has placed
pressure on the Company’s profit margins. Further, new international entrants to the market such as Zara and
H&M have increased the competition within the retail fashion sector.

DuoMake’s two items produced are; the Recycled Frill Dress and the Classic Laced Dress. The Company is
concerned that the costing of the products is incorrect due to the recent decline in sales. DuoMake have
provided the following total information for the financial year ended 30 June 2017 relating to each of the
dresses.

Totals (Rand) Note Recycled Frill Lace

Sales 5 000 000 3 600 000
Cost of Sales A1 2 600 000 1 800 000
Gross Profit 2 400 000 1 800 000
Volume Produced A2 5 000 4 000

A1: The cost of sales figure relates to direct labour and direct material costs for each dress. The direct labour
hours required per individual dress is 8 hours for the Recycled Frill and 6 hours for the Lace Dress.

A2: All goods were produced and sold in the current financial year. DuoMake currently utilises the traditional
costing method with Labour hours used as the allocation base.

The total overheads incurred are split in to the activity cost pools, which indicates the nature of each activity
cost pool. The total overhead costs incurred by DuoMake for the past financial year is detailed below:

Total Overheads Note Amount (Rand)

Manufacturing
Machinery 1 000 000
Garment Assembly 400 000
Quality Control 300 000
Delivery 750 000
Non-Manufacturing
Salaries B1 450 000
Advertising B2 80 000

B1: The salary cost relates to the factory manager. An analysis of the time of the manager indicates that 40% of
their time was devoted to general factory floor issues, with the remainder shared equally between the 2 dresses.

B2: The total advertising cost relates to the general advertising of the brand to create awareness for the start-
up Company. The marketing manager was unsure how to treat the cost and recommended that the advertising
cost be allocated to each dress and based on sales revenue proportion.

The additional information relating to the cost drivers of the manufacturing activities is provided:

12
 Cost Driver Note Actual Budgeted Practical
Number of Machine N1 32 000 40 000 50 000
Hours
Labour Hours N2 64 000 65 000 72 000
Number of Batches N3 ? 350 380
Number of deliveries N4 ? 350 400

N1: The machinery overhead includes depreciation of R300 000. The other costs relate to electricity and
maintenance of the equipment utilised to manufacture the garments. The machinery overheads are driven by
the number of machine hours and can be considered fixed in nature.

N2: The garment assembly overhead is variable in nature and driven by labour hours.

N3: The quality control activity is crucial for DuoMake. The Company prides itself on the quality of goods
produced. The quality control activity involves inspecting 3 dresses per batch to ensure the quality standards
are maintained by the Company. The number of dresses per batch are 20 for the Recycled Frill and 32 for the
Lace Dress. The quality control overhead is variable in nature.

N4: The delivery activity includes all costs related to the delivery of the dresses from the factory to the store.
The delivery cost is influence by numerous factors such as distance to travel, petrol cost, as well as the costs
detailed below. DuoMake acquired a small delivery vehicle to assist in the delivery of the dresses as well as
employed a driver to deliver the goods. The appropriate costs associated with each item is included in the activity
overhead cost pool.

The delivery overhead cost driver is the number of deliveries, each delivery trip is only able to load and deliver
one batch - of either the Recycled Frill or Laced dress.

The delivery cost information below relates to the actual cost incurred for 3 months in the past financial year:

Month November January May

Deliveries 40 31 25
Cost 75 000 65 000 50 000

The total actual usage of the cost driver is provided for the two dresses:

Total Cost Driver Usage Recycled Frill Lace Notes

Number of Machine Hours 20 000 12 000
Labour Hours 34 000 30 000
Number of Batches ? ? Refer to N3
Number of deliveries ? ? Refer to N4

13
Required:

Number Question Marks

1. Calculate the profit per dress (per unit) for both the Recycled Frill and
Laced Dress, based on the traditional method. 5 Marks
2. Evaluate the comment by the marketing manager in note B2 relating
to advertising. Comment on following in relation to Activity Based
Costing method: 2 Marks
- The accuracy of the statement, and
- The nature of the cost driver proposed
3. Calculate the profit per dress (per unit) for the Recycled Frill and Laced
Dress, based on the Activity Based Costing method. Assume the 21 Marks

advertising cost from question 2 is not allocated to the product.

4. Detail the disadvantages associated with an Activity Based Costing
method 3 Marks
5. Compare the profit per dress calculate in question 1 (traditional) and
question 3 (Activity Based Costing). Comment on:
- Reasons for differences in the profit
6 Marks
- Evaluate which costing method is more appropriate
- Which product should be emphasised more of the two
- Other valid comments

Professional communication: Format, layout of workings, and communication 3 Marks

Total 40 Marks

14
AB04 Umzobo (Source: 2018) (40 Marks)

Umzobo (Pty) Ltd (hereafter referred to as “Umzobo” or the “Company”) provides a wide range of services
to Small & Medium Enterprise’s (SME’s) within the fashion industry. The primary services provided by
Umzobo is the production of designed garments, the creative design in developing the garment idea
concept, and marketing services. The services are valued by the SME clients as they do not have access to
the capital resources required to independently invest in these activities.
Umzobo is a proudly South African Company and sources all required resources locally. The fashion
industry has grown with the rise in prominence of fashion conscious social media stars. The current date
is 31 December 2017 which coincides with the year-end for the company.
Umzobo currently services 14 clients, each of which have vastly different resource requirements. The vast
difference in the resource requirements is depicted as an example in the production of a garment; a simple
plain white T-shirt would require limited labour and machine hours to produce and assemble, whereas a
complex beaded dress would require numerous labour hours and machine hours to produce and assemble
the garment.
Due to the varying nature of resources required, Umzobo charges clients a standard mark-up of 25% to
the attributable costs required by the client. Costs are currently allocated to clients based on IAS 2,
Inventory using labour hours as the allocation base.
Of late, Umzobo has experienced declining profit margins which has concerned management. This has been
especially disappointing given that the South African economy has begun to show signs of growth which has
spilled over to the retail industry. Umzobo has been unable to capitalise on this growth spurt and the
Company’s financial manager, Nomi Mateta, has expressed that she believes that this is due to an
ineffective costing system. She has suggested that an alternative system such as an activity- based costing
system be implemented. This suggestion has been met with much criticism by senior management who
have cited that they believe that implementing such a system will result in unnecessary costs being
incurred.
Umzobo is most concerned about two of its clients, Khanyi and Luzuko, as they are responsible for almost
25% of the Company’s total revenue. Khanyi has been a client of the Company for almost four years. Khanyi
makes use of the majority of Umzobo’s resources to produce and market her highly successful traditional
skirt line. Luzuko is an established designer of African themed dress shirts. He predominantly relies on the
use of Umzobo for the manufacture of these shirts. He has been a client of the Company for the last two
years. These two clients drove Umzobo’s strong financial performance in recent times.
Information relating to total resource consumption of services for Khanyi and Luzuko for the year ended 31
December 2017 is as follows:

Total consumption Note Khanyi Luzuko

Direct Materials N1 R28 550 R44 200
Direct Labour N2 R54 400 R80 750
Machine hours 360 4 550
Number of units per batch 90 50
Number of units Produced 450 650

Note 1: Umzobo sources a range of high quality raw materials for clients based on their specific needs.
This typically includes high quality fabrics, cotton, buttons, zippers and other such materials at competitive
prices.
Note 2: Direct labour includes wages paid to staff responsible for the production of clients’ garments. The
production staff are paid at a rate of R85 per hour.

15
The total overhead information provided below relates to the last financial year-ended 31
December 2017 for Umzobo. Total overheads, for the Company, amounted to R5 500 000 for the
year. Information relating to these total overheads for Umzobo are provided as follows:

Percentage of Total
Cost Note Overheads Nature Cost Driver*
Advertising N3 10% Non-manufacturing No. of Units
Administration
Salaries N4 15% Non-manufacturing No. of Units
Square meters
Rental N5 25% N5 occupied
Supervisors’ Salaries N6 15% Manufacturing No. of Batches
Water & Electricity N7 15% Manufacturing Machine hours
Depreciation of
Machinery N8 20% Manufacturing Machine hours
Total 100%
*Please note all cost drivers are to be considered whether they are appropriate.

Note 3: Advertising relates to costs incurred to market the products of clients in local magazines.
Of the total cost, 10% relates to the Khanyi whilst 5% relates to Luzuko. The cost is considered to
be fixed in nature.
Note 4: 90% of the administration salaries is incurred to support Umzobo’s operations in its
entirety and this portion is fixed in nature. The remaining portion of 10% of the cost relates
specifically to support Khanyi and her operations. Khanyi’s portion of the cost is variable in nature,
dependant on temporary employees hired.
Note 5: The rental cost is for a single facility situated in Epping, Cape Town, used for both
administration and production functions. Umzobo entered into a long-term lease to secure the
premises for the foreseeable future at a low guaranteed rental rate. Of the facility, 20% is
attributable to Umzobo’s central administration headquarters and the remaining space is used for
the production and design of garments as required by the clients. Khanyi and Luzuko garments
currently comprise 10% of the production space.
Note 6: This cost relates to a supervisor employed on a permanent contract to specifically inspect
the quality of products produced – this is important for Umzobo whom prides itself on the high-
quality provision of services. Inspections are performed by the supervisor on a batch basis.
Note 7: The following data was collected relating to the previous four (4) years of operation:

Period Cost Machine Hours

2013 R525 225 28 850
2014 R569 000 34 000
2015 R503 550 26 300
2016 R471 250 22 500

The water and electricity cost relates primarily to usage in the provision of services to clients.
Note 8: The depreciation cost, allocated on a straight-line basis, is attributable to the numerous
machines used in the production and design services of Umzobo.

Information relating to the various cost drivers for all of Umzobo’s operations for the year ended 31 December

16
 2017 is as follows:

Capacity Levels Actual Normal Practical

Number of Units Produced 6 340 7 200 9 000
Machine Hours 23 500 26 000 31 000
Direct Labour Hours 16 500 18 000 24 000
Number of Batches 85 90 100
Square Meters Occupied 120 120 120

Additional information:
• Budgeted capacity is based on normal capacity for the year.

REQUIRED MARKS
1. Advise Nomi (the financial manager of Umzobo) on whether it would be 5
appropriate for Umzobo to implement an activity-based costing system.

2. Calculate the total overhead costs to be allocated to Khanyi and Luzuko (clients) 7
in terms of a traditional costing system, for 2017 if Umzobo used labour hours as
an allocation basis.

3. Calculate the total overhead costs that would be allocated to Khanyi and Luzuko 16
(clients) for 2017 if Umzobo applied an activity-based costing approach.

4. Evaluate and comment on the results of question 2 and question 3 relating to 9

the costing of services provided to Khanyi and Luzuko. Discuss the potential
implications of the calculations for Umzobo.

Overall: Professional communication, clarity of workings, and presentation. 3

TOTAL 40

17
AB05 UCT (2010) (45 Marks)

The Universal Campus of Technology (UCT) is a university situated in Cape Town. UCT has been in existence
for over 100 years and operates on a large campus with over 20 buildings. The campus has a vast mix
between new and old buildings.

In an effort to provide the cheapest and most efficient maintenance service to the faculties that use these
buildings, a maintenance service department (MSD) was established 4 years ago. The MSD is a cost centre
and provides all maintenance services required by the buildings.

Recently UCT’s chief financial officer (CFO), Manny Delgado, has been receiving numerous complaints from
the faculty deans concerning the large maintenance costs allocated to their respective faculties. The deans
are claiming that the allocated maintenance costs are far higher than what they are actually using.

Manny informed the deans that a formal investigation would be performed, however he warned that it was
unlikely that the results of the investigation would help their argument. He explained that since his
appointment as CFO, he had implemented a system of activity-based costing (ABC) to allocate
maintenance costs to the various buildings (refer Appendix A).

Manny is further disturbed that a large amount of the feedback from student evaluation forms shows that
the students are unhappy with the quality of the facilities at present e.g. air conditioners not working, and
lights broken in exam venues. There is also a feeling that the MSD are over invested in capacity with the
majority of the costs being fixed. However, the current ABC system is not showing any unallocated cost of
spare capacity.

Presented in Appendix A is information regarding the current ABC system employed by UCT w.r.t. the MSD.
The information shows the maintenance costs allocation to 2 of the buildings, namely the Commerce
Building and the Engineering Building.

Commerce Building:

The commerce building is one of the oldest buildings on campus. This building follows an old-fashion
layout, with corridors and reception areas being relatively small, allowing for the greatest amount of space
being used for offices. The floors are carpeted, with dry-wall partitions. From the outside the building is
not aesthetically pleasing, with raw (unpainted) concrete finishing on the exterior walls, and ivy growing
up the front of the building. The concrete finishing is especially designed not to deteriorate in bad weather,
thus requiring no paintwork over this finish. The ivy that grows on the front walls requires constant
attention from the gardening staff. The Dean of the Commerce faculty had requested that the ivy be
cleared away as this would save the university in gardening costs. This motion was rejected by the Vice
Chancellor claiming that the ivy was part of UCT’s heritage and brand name. The building also has some
flowerbeds decorating the entrances to the building.

The Commerce building was originally designed for low amounts of human traffic and so the bathrooms
on average only have two toilets and two basins. However, with the increasing volumes, the Commerce
faculty has been forced to install more bathrooms per floor. To limit costs, rather than to redesign the
building layout, each floor increased the number of bathrooms by converting existing offices that were only
big enough to have two toilets and one basin.

18
Engineering Building:

The Engineering building is the pride of the faculty. The building was completed last year and is
the vision of architectural brilliance. The building has a very modern style with large glass walls
on the ground floor and glossy tiled floors. The floor plan is designed to have a very open layout
allowing for much larger common space. The building is situated at the back of the campus and
as such is not required to have the same traditional appearances as the Commerce building. The
Engineering building is fitted with laboratories. These laboratories are fitted with running water
and washing area’s to clean the apparatus. The new building was designed to handle large volumes
of people; each bathroom in this building has on average 6 toilets and 3 basins.

An investigation into the nature of what drives these maintenance costs revealed the following:
Maintenance cost is made up of:

Cost Type Notes

Plumbing Maintenance, Water and Sewerage N1
Window Cleaning N2
General Cleaning N3
Repair Call Out Costs N4
Gardening N5
Painting N6
Fumigation N7

Notes:

N1: Plumbing maintenance, Water and Sewerage:

Plumbing maintenance, Water and Sewerage are allocated to the faculties based on the number
of bathrooms in each building. The majority of the plumbing maintenance cost is caused by
blocked pipes. Pipes are mainly blocked from cleaning experiment apparatus; when these
instruments are cleaned, chemical residue is washed down the sink blocking the pipes. In addition,
it is policy for MSD to perform routine plumbing checks on all the toilet-water-points every 6
months. This is done to avoid the toilets blocking which is far more expensive to fix and is very
disruptive to the work environment. Water and sewerage fees are charged by the municipality
based on the number of water points (basins, taps and toilets) UCT is using.

N2: Window Cleaning

Window cleaning costs are allocated on the number of windows in each building. The Commerce
building requires the windows to be cleaned every three months, whereas the Engineering
building has the glass walls cleaned once every two weeks.

N3: General Cleaning

General cleaning costs relate to the everyday cleaning of the building, emptying bins, vacuuming, etc. This
cost is allocated on the basis of floor space measured in meters squared. 40% of this cost relates to work
done by the cleaning staff in the bathrooms. This involves mopping the floors, replacing toilet rolls and
refilling the soap dispensers. Each bathroom must be checked once a day. It has been identified that it
takes one third of the time to clean a bathroom with two toilets as it takes to clean a bathroom with six.
The remaining 60% of the cost relates to cleaning of the general offices. It has been found that staff takes

19
far longer to clean the open style layout than the layout of the old buildings. Included in the general
cleaning costs is depreciation of the carpet cleaning equipment. This equipment has a useful life of 5 years
and is used to both vacuum and clean the carpeting at the same time.

N4: Repair Call-Outs

Repair call-out costs are allocated based on the number of call-outs per year. Some repairs are relatively
easy to complete, such as changing faulty light bulbs. However, during the winter rains maintenance were
kept busy by call-outs for repairing leaks in the ceiling of the older buildings, which often takes days.

N5: Gardening

Gardening costs are allocated equally to all the buildings. Gardening costs relate to the preparation of all
plants on and around the building. 40% of these costs relate to gardening of the ivy that grows only on the
older buildings.

N6: Painting

Painting costs relate to the external paintwork of the buildings. The Engineering building is repainted every
3 years as part of the faculty’s policy to uphold an image of excellence. Painting costs are capitalised and
then expensed over a three-year period until they are repainted. Manny was unsure whether to allocate
these costs or not; his conclusion was that the painting costs have already been incurred and thus are
irrelevant to the ABC costing exercise. However, he has requested that any alternative treatments be
suggested if they are thought to be more appropriate.

N7: Fumigation

Fumigation costs are allocated evenly over the 20 buildings. Fumigations are mandatory every 18 months,
alternatively a specific fumigation can be arranged with MSD. It was found that 3 of the buildings on the
South side of campus, including the Commerce building, surround the central drainage system for the
entire campus. As a result, cockroach infestations are a common occurrence and these buildings require a
lot more frequent fumigations.

SEE APPENDIX A on the pages that follow.

20
APPENDIX A: Current UCT ABC system relating to maintenance costs

Cost Type Cost Driver Total Cost

eted Activity Levels
(2011) Actual Activity Levels
(2010)
Actual (2010) Budgeted Budgeted Practical Actual Practical
(2011) Activity Capacity Activity Capacity
Plumbing etc(N1) No. of R 1 345 000 R 1 450 000 240 360 240 360
Bathrooms
Window No. of R 780 000 R 800 000 1 728 2 500 1 728 2 500
Cleaning* (N2) windows
General Cleaning* Floor space R 2 200 000 R 2 250 000 124 000 124 000 124 000 124 000
(N3) in m²
Repair Call-Out No. of Call R 2 750 000 R 2 000 000 480 650 320 650
Costs*(N4) Outs
Gardening (N5) No. of R 480 000 R 350 000 20 30 20 30
Buildings
Painting (N6) External wall R 200 000 R 210 000 12 300 18 500 12 300 18 500
area, m²
Fumigation (N7) No. of R 210 000 R 250 000 20 n/a 20 n/a
Buildings
*These costs should be regarded as fixed in nature

Commerce Building Engineering Building

Cost Pool Total Cost Total Rate Use Allocated Cost Use Allocated Cost
Activity
Plumbing etc R 1 450 000 240 R 6 042 16 R 96 667 4 R 24 167
Window R 800 000 1 728 R 463 96 R 44 444 72 R 33 333
Cleaning
General R 2 250 000 124 000 R 18 5 040 R 91 452 3 900 R 70 766
Cleaning
Repair Call-Out R 2 000 000 480 R 4 167 22 R 91 667 6 R 25 000
Costs
Gardening R 350 000 20 R 17 500 1 R 17 500 1 R 17 500
Painting R 210 000 12 300 R 17 3 780 R 64 537 2 016 R 34 420
Fumigation R 250 000 32 R 7 813 1 R 7 813 1 R 7 813
R 414 077 R212 998

21
 REQUIRED:

1) What would the objective(s) be of using an ABC system to allocate maintenance costs at UCT? You
should identify two key objectives and briefly explain each.
(4 marks)
2) For each of the seven costs making up the maintenance cost (see N1 to N7), discuss the
appropriateness of the current choice of cost driver. If you do not believe that the cost driver
currently used is the most appropriate, make a recommendation of a better choice.
(2 to 4 marks each: total = 20 marks)

3) Criticise UCT’s current ABC costing presented in Appendix A (and described in the text). For each
error or weakness identified in Appendix A, explain what the correct (or better) approach would
have been (no computations are required). (Your criticism should exclude the choice of cost driver
already covered in part 2 of the question). The arithmetic in Appendix A may be assumed to be
correct.
(13 marks)

4) One of the deans has suggested that the maintenance work should rather be outsourced to a
company external to UCT. What factors should Manny take into account when deciding whether
to continue to operate the in-house MSD or outsource this function?
(4 marks)

22
AB06* (UNSEEN) (2019 – TEST 1) (40 marks)

Phony (Pty) Ltd (Phony or the Company), established in 1989, is a local electronics manufacturer specializing
in sound device technology. Phony’s current financial year end is 31 March 2019. The Company produces a
variety of sound devices such as headphones, earphones, and speakers. Phony manufactures all its electronic
products from its factory in Paarden Eiland and to ensure superior quality products only the best electronic
components are imported from Germany. Phony was established when the Company’s founder, Prashant
Phony, broke his Walkman’s4 headphones and could not find replacement high quality headphones to listen
to his music.

Phony has distinguished itself as a Company that emphasizes quality and product innovation. In pursuit
thereof, Phony was one of the first companies to launch wireless headphones5. Wireless headphones recently
experienced significant global growth with many competitorsin the sound device sector offering wireless
headphones as a sound solution.

Despite significant initial revenue growth, recently Phony has experienced profitability concerns due to the
slow economic growth locally and the influx of cheap imported headphones. As a result of the profitability
concerns, Phony is evaluating which of their two bestselling headphones to further emphasize. The first pair
of headphones is the Music Booster (MB) which is a pair of high quality wireless headphones that has noise-
cancelling functionality and has customizable LED lighting. The second pair of headphones is the Easy Listener
(EL) which is an economical pair of headphones targeted at first time buyers. The EL’s are not wireless and
require a cord to connect to the sound device, for example a cell phone or computer.

Manufacturing Production Process

Moulding:
The first step in headphone production is the moulding of plastic into the appropriate headphone casing. The
casing is the outer circular shell of a pair of headphones in which the electronic components are located. The
plastic moulding process is completed by a moulding machine. During the past five years, the moulding
machine has operated an average of 100 000 hours per annum. The maximum hours the moulding
machine can operate, takinginto account regular maintenance, is 120 000 hours per annum. The annual fixed
cost for the moulding process is R6 000 000, of which R1 000 000 thereof relates to depreciation.

Electronics:
After the moulding process, the electronics installation process occurs. The installation process is performed
by salaried electricians, who secure the electronic components imported from Germany to the plastic
casings. The electronic components installed relate to the sound devices, which allows sound to be emitted
through a pair of headphones. Phony employs 30 salaried electricians. The electricians are skilled labourers,
which are in limited supply in South Africa. Each electrician is employed for 7 hours a day, 20 days a month
accounting for expected leave days, and earns R200 000 each per annum. Due to the

4
A Walkman was a popular listening device in the 1980’s and 1990’s that played music off a tape
cassette. 5 Wireless headphones enables a listener to move away from the source of the sound
without an attachedcord.

23
complexity of the LED lights installation in the MB, electricians spend more time on the MB headphone
installation.

Wiring and Soldering:

After the electronic components are secured in the plastic casings, the headphones are ready for wiring. The
wiring process, relating to both MB and EL, entails connecting the electronic components together with
insulated copper wire. The copper wiring is connected to the electronic components through a process called
soldering6. The wireless products Phony produces, such as MB, require less wiring due to fewer connections.
The wiring and soldering process is fully automated and the total annual cost relating to the machinery is R4
500 000. The normal and practical capacity for the wiring and soldering machinery is 55 000 and 60 000
operating hours respectively per annum.

Sound Quality Control:

All Phony products manufactured undergo a thorough sound quality check. The quality check involves a sound
technician using a computer to send sound waves through the headphones to test the frequency response.
This sound test determines how clear the sound emitted by the headphones is.

The EL undergoes one sound quality check before it is ready for sale. However, because the MB is of the
highest quality it undergoes four sound quality checks before it ready for sale. Phony has invested heavily in
its sound quality equipment and has a practical capacity of56 000 checks per annum. The sound quality
equipment is manufactured locally from the only sound equipment manufacturer in Cape Town. Furthermore,
the sound quality costs since 2016 have been as follows:

Table 1: Sound Quality Costs

Year Number of Checks Cost (R)
2016 38 400 2 335 000
2017 40 080 2 400 000
2018 36 000 2 310 000
2019 42 000 2 445 000

Packaging:
Once the headphones have passed all the sound quality checks they are packaged for delivery. All the
packaging is done by hand and Phony hires waged employees to perform all the final packaging of the
headphones. The waged employees’ costs are directly traceable to each product produced using job cards.
The waged employees are paid R40 per hour and are expected to work a total of 96 000 hours, based on the
total budgeted production for 2019. The cost of the packaging material is negligible.

Raw Materials and overhead allocation:

The copper wiring required for each pair of headphones is only available by the metre andthe copper
wiring price per metre is R120. The plastic used in the moulding process is purchased in bulk at a price per
kilogram of R250.

6
Soldering is the process of joining two or more electronic parts together by melting solder around the
connection.

24
Variable manufacturing overheads, over and above that detailed in the production process, are driven by the
number of waged employee hours worked. The variable manufacturing overheads are allocated to the
products at R4 per budgeted waged employee hour.

Management decided that the predetermined overhead rate for fixed manufacturing overheads will also be
budgeted waged employee hours because variable overheads aredriven by waged employee hours.

Phony budgeted to sell 2 500 MB and 8 000 EL, during the 2019 financial year. The selling price of the MB
and EL headphones are R1 800 and R600 respectively. The actual results were in line with budgeted for the
2019 financial year. The resources required per unit of MB and EL produced are detailed below:

Table 2: Music Booster (MB) and Easy Listener (EL)

Music Booster (MB) Easy Listener (EL)

Copper Wire 10cm 35cm
Plastic for Casings 300 grams 100 grams
Waged Employee Hours 3 hours 1 hours
Moulding Machine Hours 3.5 hours 1.25 hours
Electrician Minutes 60 minutes 30 minutes
Soldering Time 4 hours 3 hours
Sound Quality Checks 4 1

Non-Manufacturing Costs and Factory Rental

Phony runs innovative advertising campaigns on its products to develop product awareness and generate
sales. The production of the advertising campaigns is outsourced to an established advertising agency. The
contract with the advertising agency allows for 32 campaigns to be produced in a given year for an annual
cost of R3 250 000. The MB headphones will have 5 campaigns run during the year and the EL will only have
2 campaigns.

Phony rents its entire factory in Paarden Eiland for R7 000 000 annually. The premises are used as the
Company’s head office and to produce all sound devices for the Company. Phonyis unable to sub-lease any
spare square metres (m2) in terms of its rental agreement. The MB production line uses 10 000 m 2 of space
and the EL uses 6 000 m2. The total floor space of the premises is 50 000m2.

Founder’s calculation
The founder of Phony, Prashant, has recently heard of Activity-Based Costing after a discussion with one of
his newly qualified CA(SA) friends. He thinks that Phony could use Activity-Based Costing to determine whether
to prioritize the MB or EL headphones going forward. Prashant has attempted his own calculation which is
detailed in Table 3 that follows.

Product emphasis
After calculating the gross profit margins of both MB and EL, management determined that under the
traditional method the MB has a higher gross profit. Therefore, management has decided to prioritize the MB
going forward and will dedicate more resources to boosting its volumes.

25
Table 3: Production manager’s Activity-Based Costing calculation (Rounded to the nearest Rand)
Total MB Total EL
Type of Cost Cost (R) Cost Driver Activity Activity MB Usage EL Usage
Rate (R) Cost (R) Cost (R)

Moulding 6 000 000 Moulding hours 100 000 60 8 750 525 000 3 125 187 500
Electrician cost 6 000 000 Electrician Hours 96 000 63 2 500 156 250 4 000 250 000
Soldering 4 500 000 Soldering Hours 60 000 75 7 500 562 500 32 000 2 400 000
Sound Quality 2 445 000 Number of checks 56 000 44 10 000 436 607 8 000 349 286
Rental 7 000 000 Number of m2 50 000 140 10 000 1 400 000 6 000 840 000
Total Cost 3 080 357 4 026 786
Number of Units 2 500 8 000
Total Cost per Unit 1 232 503
Selling Price 1 800 600
Gross Profit per Unit (R) 568 97
Gross Profit Margin (%) 31,5% 16,1%

Additional Information:

• You may assume that the calculation in Table 3 is mathematically correct.

• 100 centimetres = 1 metre
• 1 000 grams = 1 kilogram.
 REQUIRED MARKS

1. Calculate the per unit gross profit margin percentage of the Music Booster and 10
Easy Listener headphones, using the traditional costing method.

2. Prepare a memorandum to Prashant that: identifies, explains, and corrects any 20

errors or omissions made in preparing the Activity-Based Costing calculation in
Table 3.

Prashant indicates that he is quite busy and therefore only necessary calculations
to support corrections are to be provided.

Use the following table in your memorandum:

Number of Error Identified error Explanation and
and Activity Correction of error
e.g. 1 - Overall e.g. Management e.g. When using a
allocated fixed variable costing
(This is an illustrative manufacturing system, all fixed costs
examplenot related to overheads to the cost are treated asa period
the ABC calculation, of the inventory when cost and are not
only for the company use a allocated tothe cost of
demonstration variable costing inventory.
purposes) system.

3. Discuss the strategic factors Phony should consider in determining which 8

product to emphasize.

Assume that the total cost of the headphones (including direct costs and all
overheads) using Activity-Based Costing for the Music Booster is R1 350 and
for the Easy Listener is R425.

TOTAL 38

BONUS MARKS:
Overall Presentation & Communication of Question 2: 2
- Clarity of Communication and Workings
- Format of communication and presentation

27
 MANAGERIAL ACCOUNTING II
ACC3023H
ACTIVITY-BASED COSTING
TUTORIAL SOLUTIONS

TUTORIALS

Week1 Week 2
AB01: QualityTables (Pty) Ltd AB04: Umzobo (Pty) Ltd
AB02: Theron (Pty) Ltd AB05:UniversalCampusofTechnology(UCT)
AB03: DuoMake (Pty) Ltd * AB06:Phony (Pty) Ltd *

* Unseen tutorial to be prepared

28
Solution to AB01: QualityTable

Question 1:
Traditional costing method
Allocate in terms of labour hours and only allocate the manufacturing overheads based on budgeted capacity

Overhead Cost

Equipment depreciation 800 000

Electricity 1 000 000
Quality control 1 000 000
Total 2 800 000

Budgeted labour hours 42 000

Predetermined OH Rate 66.67

Caption Classic African

Selling price per unit 14 000 18 800
Direct material per 7 500 9 000
unit
Direct labour cost per 2 500 4 000
unit
Overheads 1 667 2 667
Profit 2 333 3 133

Question 2

Overhead Activity Driver Cost Activity Level Activity Rate

Equipment depreciation Mhr 800 000 10 000 80
Electricity Mhr 1 000 000 9 000 111
Quality control Unit 1 000 000 1 300 769
Transport Batches 400 000 260 1 538
Rent M2 200 000 N/A

Profit per Unit Classic African

Selling price per unit 14 000 18 800
Direct material per unit 7 500 9 000
Direct labour cost per unit 2 500 4 000
Overheads
Equipment depreciation 400 800
Electricity 556 1 111
Quality control 769 769
Transport 308 308
Rent 400
Profit per Unit 1 968 2 412

Question 3:
The traditional method utilises labour hours as the allocation base. This is distorting the
picture of the company's operations.

Both products were under costed in the scenario. The reason for the under costing may
been that non-manufacturing costs were not accounted for.

Further the traditional costing system utilised labour hours as the allocation base which was not utilised
for any of the overhead as the most appropriate activity driver.

The labour hours is more closely aligned to the direct material/labour cost.

29
ABC does provide a more accurate costing of the product, demonstrated by the costing differences.

ABC however does not adjust the profit significantly, as the overheads of the business are not as significant as
direct costs. The direct cost make up c80% of the total costs.

ABC also demonstrates that both products are under costed and that the cost mark-up is c15% rather than the
20% per the company policy.

The costs may outweigh the benefits in this scenario for a company with high direct
costs.
Max 6

30
AB02 Solution:Theron

Part 1:
The following characteristics would suggest that ABC may be appropriate: There are
diverse products.
The indirect costs form a large percentage of total costs The
production volumes vary significantly among products
There is a belief by the operating managers that the old traditional system does not give
meaningful product costs.

Part 2:
ABC is based on the premise that only costs caused by the product should be assigned to the product
(or other cost object). Traditional costing often uses arbitrary cost drivers. ABC may use volume and
non-volume related cost drivers. Traditional costing uses volume related cost drivers.

In ABC some manufacturing costs that are not caused by the product are not assigned, whereas in
traditional costing all manufacturing overheads are assigned. In ABC, non-manufacturing costs that
are caused by the product are assigned, whereas with traditional costing, non-manufacturing
overheads are treated as period costs and written off in the income statement.

In ABC, facility sustaining costs may not be assigned to products, since the products do not cause
the incurrence of these costs. In traditional costing, facility sustaining manufacturing overhead are
assigned. In ABC, the cost of idle capacity is not assigned to products, while in traditional costing the
costs of idle capacity is assigned to products.

ABC uses practical capacity of the cost driver as the denominator volume for indirect costs that cannot
be changed in the short term i.e. are fixed w.r.t. short term decision. ABC uses actual
production/capacity of the cost driver as the denominator volume for indirect costs that can be
changed in the short term i.e. are variable w.r.t. short term decisions.

Part 3:
ABC seeks to establish the costs caused by products. If there has been investment in excess (spare)
capacity, this should not be allocated to products, since it is not caused by the product. The costs of
spare capacity needs to be highlighted to management, which is one of the roles of ABC.

Part 4:
Traditional GP per pair:
Boooth Beckham Marks
Number of pairs 10 000 5 000

direct costs 1 000 000 1 000 000 1

manufacturing OH 4 200 000 2 100 000 1
total cost 5 200 000 3 100 000

cost per pair 520 620 1

SP 540 900
GP 20 280 1

31
Part 5:

ABC GP per pair:

Boooth Beckham Marks

numberofpairs 10 000 5 000

direct costs 1 000 000 1 000 000 1

indirect costs 2 110 000 2 467 500
total cost 3 110 000 3 467 500

cost per pair 311 694

SP 540 900
GP 229 207 1
**The calculation of the OH rate applied to Boooth and Beckham, is at the end of the solution

usage of cost driver OH rate boooth beckham Marks

usage amount usage amount
no. of stitching hrs 500 2000 1 000 000 2500 1 250 000 1
no. of boxes 685 1000 685 000 500 342 500 1
no. Of batches 200 1000 200 000 1000 200 000 1
compexity to advertise 450 000 0.5 225 000 1.5 675 000 1
total 2 110 000 2 467 500

Part 6:

The traditional costing system gave a GP of R20 for Boooth and R280 for Beckham. This
suggested that Beckham is the product to emphasise in the product mix. The ABC GP of
Boooth is R229, while that of Beckham is R207. This suggests that both products have a
good margin and should be emphasised.

The reason that Boooth had such a low margin under traditional costing was that non- volume
based overheads were being allocated based on a volume based cost driver. This is rectified
under ABC. Under traditional costing, spare capacity and facility sustaining costs are costed into
the products on an arbitrary basis while ABC does not include these costs in the individual
products.

Thus, what is important to look at is not the absolute cost of the units as this will obviously be
different as different costs are included in each calculation, but rather we must look at how one
product closes the gap or even overtakes the other in terms of product cost on a per unit basis.

32
 activities

facility sustaining (not

OH cost : allocated) stitching packaging machine set up advertising
Manufacturing
Factory rental 2 000 000 2 000 000 1
Factory insurance 30 000 30 000 1
Stitching related overheads 2 500 000 2 500 000 1
Packaging related overheads 1 370 000 1 370 000 1
Machine set up related overheads 400 000 400 000 1
Non-Manufacturing
Advertising 900 000 900 000 1
Advertising (General) (N2) 300 000 300 000 1

Total 7 500 000 2 330 000 2 500 000 1 370 000 400 000 900 000 7 500 000

fixed fixed fixed variable

practical practical practical

capacity capacity capacity actual capacity

no.of no. of complexity to

cost driver name n/a stitching hrs no. of boxes batches advertise
cost driver capacity 5000 2000 2000 2 4

OH rate per cost driver 500 685 200 450 000 1

 Solution to AB04 (Umzobo)

UMZOBO SOLUTION
Part 1:
ABC usage depends on:
The proportion of overheads is high in relation to the total costs incurred - therefore misallocation may be a 1
concern. It is therefore appropriate to ensure the correct allocation of costs to ensure products are costed and
priced correctly.
The approximate overheads proportion is [5 500 000 / (5 500 000 + (207 900 / 25%))] = 87% which is significant. 1
The industry is highly competititive as detailed through the declining profit margin. This indicates the company 1
does not have a monopoly over the market.
The overhead have multiple activities driving costs and the cost drivers are different to that under IAS 2. The 1
allocation of costs could therefore be vastly different depending on the allocation method used.
There are multiple services provided and complexity of services different which indicates varied consumption of 1
overheads by the different products.
Disadvantages:
Can be costly to implement as pointed out by management. This may be an issue as the business is already 1
experiencing declining profitability which will therefore further put pressure on profit margins.
Conclude appropriately: The ABC is appropriate and should be implemented to identify potential costing issues. 1
MAX: 5
Part 2:

Khanyi Luzuko
Direct 28 550 44 200
Materials
Direct Labour 54 400 80 750
Manufacturing Overheads 136 889203 194 W1
Total Cost 328 144 Not required in terms of the question
219 839

W1: Total MOH

Rental 1 100 000 = 80% x 25% x 5.5m 1
Total manufactoring OH 2 750 000 = (15%+15%+20%) x 5.5m 1
Depreciation 1 100 000
Supervisor 825 000
Water & Electricity 825 000
Total 3 850 000

Normal Labour Hours for 18 000 Given 1

Company
OH/Labour Hour 214 1

Khanyi Labour Hours 640 = 54 400 / 85 1

Luzuko Labour Hours 950 = 80 750/85 1

Khanyi Allocated 136 889 = 214 x 640 1

Luzuko Allocated 203 194 = 214 x 950

34
 Part 3:

Khanyi Luzuko
Direct Materials 28 550 44 200
Direct Labour 54 400 80 750
Oveheads 197 836 375 973
Total Cost 280 786 500 923 Not required in terms of the question

W2:

The Khanyi The Luzuko

Overhead Working Cost Activity Level OH Rate Usage Alloc. Usage Alloc.
Advertising 550 000 10% 55 000.00 0.5 5% 27 500.00 0.5 1
Admin Salaries W3 825 000 Remainder facility sustaining 1 10% 82 500.00 1 2
Rental Facility Sustaining 1 1
Supervisor W5 825 000 100 8 250.00 1 5 41 250.00 1 13 107 250.00 1 3
Water & Elecrtricity W4
- Fixed 280 000 31 000 9.03 2 360 3 251.61 0.5 4 550 41 096.77 0.5 3
- Variable 8.50 1 360 3 060.00 0.5 4 550 38 675.00 0.5 2
Depreciation 1 100 000 31 000 35.48 1 360 12 774.19 0.5 4 550 161 451.61 0.5 2
Total Overheads: 1 197 835.81 375 973.39 1 2
Total: 16
W3:

Mark breakdown
Khanyi 82 500 = 10% x (15% x 5.5m) 1
The remaining admin salaries are facility-sustaining 1

W4: Hi-Lo
Change Cost 97 750.00 = 569 000 - 471 250
Change Activity 11 500.00 = 34 000 - 22 500

VC/Hr 8.50 = 97 750 / 11 500

FC 280 000.00
 W5: Actual Batches:
Khanyi 5 = 450 / 90
Luzuko 13 = 650 / 50

Part 4:

When considering ABC, we see that both products are when using IAS 2
undercosted.

Khanyi undercosted by 60 947

Luzuko undercosted by 172 779

The undercosting is significant for Luzuko which is 85% undercosted based on current overheads.

The undercosting could be as a result of:

The costs allocated are different though not significant in total.

Rental is the most significant overhead which is not allocated in terms of ABC yet ABC still is greater.

There are some non-manufacturing overheads allocated however these are not significant.

Therefore it is the allocation base used is the biggest reason for the difference.

The driver of direct labour hours used in IAS 2 is not representative of the usage based on cost drivers

The variety of drivers more approximate usage and provide a different picture

The different capacity levels ensures that spare capacity is not allocated.

Accuracy of calculations or the cost drivers may be brought into question is there a cause effect relationship

Implications include:

The incorrect pricing applied for the services and potential loss making in the future
These are the 2 key clients therefore consider keeping them and charging a discount in the hope of future business

To be associated with key up and coming designer.

Implementation of ABC allows a focus on cost control of Overheads which is a significant cost for business
AB05 – SOLUTION

1) Marks
The system would have two or three key objectives: 2
• To allocate costs accurately in line with cost causation, so that departments are

charged for the costs that they cause to be incurred and only charged costs
that they are responsible for. 2
• By charging departments / faculties based on resources used, cost control will be 2
encouraged, as faculties / departments would try to use resources (the MSD
department) efficiently in order to reduce the costs that they are charged.
• Further, the more accurate costs should allow for improved planning,
budgeting and decision making (more accurate cost information, the
behaviour of maintenance is better understood and more accurately
predictable).
Total available 6 marks
Maximum 4 marks

2) Marks
Plumbing Maintenance, Water and Sewerage:
• The number of bathrooms is not an appropriate cost driver(1). The plumbing

costs are driven by the number of water points in each building and the
laboratories in the engineering building(1)
• A more appropriate cost driver would be the number of water points in each

building.(1) This is because the maintenance costs are mandatory for every
building, and is driven based on the number of water points that exist.(1)
• As the number of water points differs greatly to the number of bathrooms, this

is likely to drastically effect the accuracy of the allocation(1).

• The chemical blockages from the laboratories could take a lot longer to fix as the

blockages could be less routine as different substances will require different

clearing methods. Thus a duration cost driver could be more useful such as
labour hours.
• Do the chemical blockages corrode the plumbing system? The laboratories could

require accelerated piping replacement as a results of washing out corrosive

material and so a intensity cost driver could be more appropriate?

Window Cleaning:
• The number of windows is not an appropriate cost driver.(1) The cleaning costs

will depend on how regularly the windows are cleaned and the size of the
windows.(1)
• A more appropriate cost driver could be the size of the windows as larger

windows will take longer to clean. (1)The glass walls may only be regarded as one
window, where as these walls drive the majority of the cleaning costs.
• Alternatively the number of window cleaning assignments could be used as
this will capture the fact that the engineering department has its windows

38
 cleaned far more frequently than the commerce building and as such is driving far
more of the cost.(1)

General Cleaning:
• Floor space is not a very accurate measure of what is driving the cleaning costs

as the buildings with dense office space are quicker to clean than the buildings
with the open style layout.
• 40% of the cost allocated on floor space is in fact to be driven by the number of

water points within the building. This cost should rather be included in the cost
pool for plumbing, allocated on the number of water points.
• Depreciation for carpet cleaning equipment is a cost specific to the older

buildings with carpeted floors. This cost should be treated as a direct cost.

Repair call out costs:

• Call out costs are allocated based on the number of call outs per year,

however the repair jobs required vary greatly in complexity.

• This is clearly not accurate as the cost charge for changing a light bulb will be the

same as the cost charged to fix a leak.

• As some repair jobs are far more complicated than others and are more time

consuming, this cost could be more accurately allocated based on labour hours
required to completed the job.

Gardening:
• The remain gardening space should be allocated based on a reasonable cost rive

such as meters squared of garden space, as the bigger the garden space the more
of the gardening cost it is likely to drive.

Painting:
• As the paint work will be incurred every three years, the amortised cost

although not relevant as it is not a cash flow, will approximate the future
relevant cost of having the buildings repainted.

Fumigation:
• Fumigation costs should be allocated based on the number of requests for

fumigation, not the number of buildings.

• Clearly the number of buildings has no bearing on how often fumigation

requests are made and some buildings require more fumigation than others and
so these buildings drive more of the cost. This is not indentified when costs are
allocated based on the number of buildings.
Total available
Maximum 20 marks

39
3) Marks
Budget vs Actual:
• The current system is using the budgeted activity levels for 2011 with the actual

costs from 2010. This is inconsistent. The system must use actual costs with actual
activities or budgeted costs with budgeted activities.
• From the perspective of cost control, the system should be working with

budgeted costs and budgeted activities.

Activity Level:
• Window cleaning, general cleaning and repair call out costs are all fixed costs. The

appropriate activity level to be used here is practical capacity not actual activity
levels.
• This is important to ensure that the cost of spare capacity from these cost pools is

not allocated to the faculties, as the inflated charge does not reflect the cost of
providing the service (i.e. the cost of using the resource, which is the objective of
an ABC system!).
• The MSD appears to have significant levels of spare capacity, which has

significantly increased the amount departments are charged, supporting the deans
concern that departments / faculties may be being overcharged.

Allocation of direct costs

• Direct costs have been included with total overhead costs to be allocated.

This supports the deans concern that faculties are being inaccurately charged. For
instance:
o Painting costs should be allocated only to the buildings with external paint

work not to the buildings with the concrete finish that do not require paint.
The commerce building is currently being charged R64k for painting, 15% of
its total maintenance costs, for a resource it is not using!!
o If the ivy cost is allocated (see below) it would be specific to the buildings

with ivy and allocated directly to these buildings, not based on activity.

Allocation of non-controllable costs

• One of the objectives of an ABC system is to improve cost control by holding users

accountable for the costs that they cause to be incurred.

• The cost relating to gardening the ivy should not be allocated to the building as the
faculty deans are not permitted to clear the ivy – they consequently cannot control
the cost thereof. The result of allocating these costs is a performance evaluation
system that can be regarded as unfair, in this regard.
• Further, as the ivy would remain on the building even if the building was not used
– as it is part of the heritage and brand name of UCT, it is a facility sustaining cost
and should not be allocated.

There is no indication of whether facility sustaining costs have been considered and
excluded.
Customer dissatisfaction: (2)

40
 The customers (deans) are complaining and do not feel that the allocated charges
is fair. This may indicate that the ABC system is not working as it should, or the
deans may be out of touch with maintenance charges. There is some truth in their
claim – cost of spare capacity is currently being included in the service rate.

Total available 22 marks

Maximum 13 marks

4)

• If the outsourcing option can save the university money, then it should be taken, based on relevant costing
principles.

• However, if the ABC system is inaccurate then the charge calculated under ABC may over stated and as such
the decision to outsource may be accepted when in reality this is the more expensive option.

• Manny should reassess the ABC system in place and make all the necessary improvements to ensure the
results obtained are accurate.

• If the new ABC charge is still higher than the cost of outsourcing, then the faculties should be allowed to
outsource that their discretion as the outsourcing charge is more competitive than what MSD can provide in-
house.

• The current systems information is likely to be accurate from a data collection perspective as the current cost
drivers are relatively easy to measure.

• However these cost drivers are not appropriate. If the system is updated to incorporate more appropriate cost
drivers, then how reliable will the data collected on these new cost drivers be?

41