One of the clients Joe Holby has built up JH Laundry Services Ltd., over the last 20 years and uses tradition absorption costing method to calculate and charge overheads to his clients.
He currently has the local hospital, a number of nursing homes and hotels as customers. Due to the bulk nature of work the cost unit is based on 1000 items of laundry.
Forecast data for next year:
Number of cost units to be processed 48000
Collection/delivery miles 100000
Current allocation and apportionment of overhead 80% Laundry
Having been involved in the preparation of the management accounts, you have determined the main activities and cost drivers of the business are:
Cost pools % of total overheads Driver
Collection and delivery of laundry 15 Transport miles
Loading / unloading of vans 10 Transport runs
Laundry / washing 35 Kg dry weight
Drying 25 Kg wet weight
Steam pressing 15 Cost unit
Last year there were 8,000 transport runs, 3000000kg dry weight of items and 4000000kg of wet weight of items cleaned with 48000 cost units requiring steam pressing. Over the years the cleaning and processing of laundry has become more mechanised, whilst the customers are asking for more regular collection and delivery of laundry. You believe that activity based (ABC) costing would better help set next year’s selling contract prices for his customers.
You talk with Joe about how the cost of overheads, are related or caused by certain cost drivers and he asks to explain this further and provide examples for his business to help him understand how ABC could help.
He provides you data for two existing contracts: Community Hanson
No. of cost units 9000 3000
No. of transport runs 1200 300
Transport – miles 6000 8000
Average dry weight per 1000 items 40kg 80kg
Average wet weight per 1000 items 66kg 106kg
- Compare and contrast the use of absorption costing and ABC costing
to charge overheads to output
- Calculate the overhead absorption rate for laundry and transport
and the overhead charged to each contract
- Calculate the cost driver rate and the overhead cost charged to
each contract using ABC costing
- Prepare notes for an upcoming meeting with Joe to discuss whether
changing to ABC costing would help him price his contacts, including
any advantages or disadvantages of changing.
Total 35 marks