Production overheads are costs incurred in an organization that cannot be directly attributed to any products. Therefore, the costs should be shared across the products. The overheads need to be shared fairly to ensure that the gains from the sale of the product are not understated. There are three main steps of sharing the production overheads. These processes are the allocation of costs, apportionment, and absorption of costs. This paper discusses various methods of allocating costs (traditional method and activity-based costing) using two companies.
Hula Hug Corporation
Part one – allocation of cost using the traditional method
Part two – activity proportions
Activity-based costing assigns actual consumption to each cost center. Activity proportions are used for each unit. The activity proportions are summarized in the table below.
From the table, the activity proportions for material handling is $19.65, quality control is $7.5, and maintenance is $0.80.
Part three – allocation of overhead
The table below summarizes the costs allocated to each cost center.
The total overhead for the roundabout model amounts to $73,098.75.
Part four – allocation of cost
The total overhead for the Sassafras model amounts to $58,101.25.
Part Five – comparison of costs
From the table, ABC costing assigns more costs to the Roundabout model than the traditional costing. The ABC method is more accurate than the traditional method of allocating costs.
Part one – traditional costing method
Based on the traditional method of cost accounting both sportsman and expedition models will have an equal amount of cost amounting to $5,590
Part two – Production cost per unit
The table below summarizes the production cost per unit under the traditional costing system.
The overhead per unit of sportsman model amounts to $4.658 while for expedition amounts to $5.82. This implies that the production of more units reduces the cost per unit. The table below summarizes the total cost per unit of the models.
Part three – gross margin
Part four – activity proportions
Part Five – overhead assigned
Part six – Production cost per unit
Part seven – gross margin
Part eight – comparison of gross profit margin
The traditional approach yields higher profit for the expedition model while under ABC the profitability of the model reduces. The gross margin for sportsmen under the traditional method was lower than that under the ABC method.
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