Moreover, the application of activity based costing takes into account activity centers. Activity centers are units within a firm that perform an activity. As such, the number of production runs can be attributed to the manufacturing process while the selling and administrative costs can be attributed to the number of sale agents employed by a firm. As such, if an activity takes 30% of time available in the manufacturing, we can assume that it accounts for 30% of the total production costs. On the other hand, if a product requires 45% of the total sales representatives in the firm, we can assume that it accounts for 45% of the selling and administrative costs accrued by the firm. Therefore, more costs are allocated to the activity that takes more of the production time or the one that requires more setups, while the vice versa is also true (Herman son, et al, 2011).
Allocation of fixed costs
Product A B
Sales 480*2000=960,000 180*6,000=1,080,000
Direct material 280*2,000=560,000 40*6000=240,000
Direct labor 60*2,000=120,000 60*60,000=360,000
Variable overhead 40*2,000=80,000 20*6000=120,000
Variable selling 13*2,000=26,000 9*6,000=54,000
Contribution sales-variable expenses
960,000-786,000=174,000 1,080, 000-600,000=480,000
Manufacturing 65/100*200,000=130,000 35/100*200,000=70,000
Selling 15/25*100,000=60,000 10/25*100,000=40,000
Profit/loss contribution-fixed costs
174,000-190,000= (16000) 306,000-110,000=196,000
Per unit -16,000/2000= (8) 196,000/6,000=32.67
The fixed costs are allocated on the basis of ABC accounting system. Therefore, in allocating the fixed costs, pertaining to the manufacturing process, production runs are taken into account. This means, product A accounts for 65% of the manufacturing costs as per the production runs while product accounts for 35% of the fixed manufacturing costs. On the other hand, the fixed selling and administrative costs are determined by the number of sales representatives with product A absorbing 60% of the costs and product B 40%.
Product B is far more profitable relative to product A. this is because product B makes a profit of 196,000 while product A makes a loss of 16,000. The loss in product A can be attributed to the high fixed costs involved since the contribution is not enough to cover them. On the other hand, product B has a high contribution figure, covering all the fixed costs, and thus making a profit.
Herman son, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73. http://textbookequity.com/oct/Textbooks/TBQ_PA_Accounting_managerial.pdf
Walther, L.M. (2010). Principles of Accounting: A Complete Online Text, chapter 19 (the section titled Modern management of costs and quality) and 20 (the section titled Activity based costing). Retrieved from http://www.principlesofaccounting.com/
Madegowda, J. (2007). Management Accounting, Global Media (read chapter 9), from library portal.
Martin, J.R. (n.d.) Management Accounting: Concepts, Techniques, and Controversial Issues - Chapter 8: Introduction. Management And Accounting Web Home Page. Retrieved from http://maaw.info/Chapter8.htm