Case Study: Activity-Based Costing (ABC) in Manufacturing

Introduction: Activity-Based Costing (ABC) is a costing method that identifies and assigns costs to activities based on their consumption of resources. This case study demonstrates the implementation of ABC in a manufacturing company.

Scenario: XYZ Manufacturing Company produces two types of products: Product A and Product B. The traditional costing method used by the company allocates overhead costs based on direct labor hours. However, the management team suspects that this method may not accurately reflect the true cost of each product.

Data:

Overhead costs: $100,000

Direct labor hours for Product A: 500 hours

Direct labor hours for Product B: 1,000 hours

Number of setups for Product A: 10

Number of setups for Product B: 5

Machine hours for Product A: 200 hours

Machine hours for Product B: 300 hours

ABC Analysis:

Identifying Cost Drivers:

Cost drivers are activities that cause costs to be incurred. In this case, the cost drivers identified are setups and machine hours.

Calculating Overhead Rates:

Overhead rate for setups = Total overhead costs / Total number of setups

Overhead rate for setups = $100,000 / (10 + 5) = $5,000 per setup

Overhead rate for machine hours = Total overhead costs / Total machine hours

Overhead rate for machine hours = $100,000 / (200 + 300) = $200 per machine hour

Assigning Overhead Costs:

Overhead costs for Product A:

Setup costs = 10 setups $5,000 per setup = $50,000

Machine hour costs = 200 machine hours $200 per machine hour = $40,000

Total overhead costs for Product A = $50,000 + $40,000 = $90,000

Overhead costs for Product B:

Setup costs = 5 setups $5,000 per setup = $25,000

Machine hour costs = 300 machine hours $200 per machine hour = $60,000

Total overhead costs for Product B = $25,000 + $60,000 = $85,000

Conclusion: The ABC analysis reveals that Product A incurs higher overhead costs than Product B, contrary to the traditional costing method. This information allows XYZ Manufacturing Company to make more informed pricing and production decisions.

Objective Question:

According to the ABC analysis, which product incurs higher overhead costs?

A) Product A B) Product B C) Both products incur the same overhead costs D) It cannot be determined from the given information