Jack and Larry Ltd is a road construction company in the UK which currently uses absorption costing for pricing its contracts. Their new accountants have recommended to the board that the business should experiment with an Activity Based Costing system, as it provides more accurate costing and pricing information. Whilst the manufacture of roads is very labour intensive, a large amount of machinery and equipment is used which incurs considerable overheads. The current annual budget for the company is as follows: Sales revenue Direct materials Direct labour Overhead costs Operating income £000s 125,000 30,000 60,000 20,000 15,000 The company currently absorbs its overheads as a percentage of the total cost of direct labour and their standard profit margin is 60% of total cost. As part of their investigation into ABC, they wish to compare the two costing methods on a quote for a new road that they have tendered for, called the A1997. The cost of direct labour to be used on this job is £600,000. Their accountants have broken down the overheads into the following annual analysis for the company: Activity Specialist equipment hire Employment of agency labour Personal and employers liability insurance costs Administrative support External surveyor advice Cost driver % of Annual use overheads of cost drivers Number of days hire 45% 8,000 days Hourly rate 25% 20,000 hours No of employees 15% 300 employees Hourly rate 10% 5,000 hours Number of reports 5% 1,000 reports The new road will cause the following activities to happen: Activity Specialist equipment hire Employment of agency labour Personal and employers liability insurance costs Administrative support External surveyor advice Cost driver Number of days hire Hourly rate No of employees Hourly rate Use of cost drivers 50 days 750 hours 20 employees 125 hours Number of reports 6 reports Required: a) Calculate the full cost and selling price for the A1997 road: using: i. The Absorption Costing method ii. The Activity Based Costing (ABC) method b) Comment on your findings and advise which method is more appropriate for Jack and Larry Ltd. c) Discuss the advantages and disadvantages of the Absorption Costing and Activity Based Costing methods.
Jack and Larry Ltd is a road construction company in the UK which currently uses
absorption costing for pricing its contracts. Their new accountants have recommended
to the board that the business should experiment with an Activity Based Costing system,
as it provides more accurate costing and pricing information.
Whilst the manufacture of roads is very labour intensive, a large amount of machinery
and equipment is used which incurs considerable overheads.
The current annual budget for the company is as follows:
£000s
Sales revenue 125,000
Direct materials 30,000
Direct labour 60,000
Overhead costs 20,000
Operating income 15,000
The company currently absorbs its overheads as a percentage of the total cost of direct
labour and their standard profit margin is 60% of total cost.
As part of their investigation into ABC, they wish to compare the two costing methods on
a quote for a new road that they have tendered for, called the A1997. The cost of direct
labour to be used on this job is £600,000.
Their accountants have broken down the overheads into the following annual analysis
for the company:
Activity Cost driver % of
overheads
Annual use
of cost drivers
Specialist equipment hire Number of days hire 45% 8,000 days
Employment of agency labour Hourly rate 25% 20,000 hours
Personal and employers liability
insurance costs
No of employees 15% 300 employees
Administrative support Hourly rate 10% 5,000 hours
External surveyor advice Number of reports 5% 1,000 reports
The new road will cause the following activities to happen:
Activity Cost driver Use of cost drivers
Specialist equipment hire Number of days hire 50 days
Employment of agency labour Hourly rate 750 hours
Personal and employers liability
insurance costs
No of employees 20 employees
Administrative support Hourly rate 125 hours
External surveyor advice Number of reports 6 reports
Required:
a) Calculate the full cost and selling price for the A1997 road: using:
i. The Absorption Costing method
ii. The Activity Based Costing (ABC) method
b) Comment on your findings and advise which method is more appropriate for Jack
and Larry Ltd.
c) Discuss the advantages and disadvantages of the Absorption Costing and Activity
Based Costing methods.
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