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.

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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

Overheads                                                                            £800000

 

Current allocation and apportionment of overhead       80% Laundry

20% Transport

 

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

Hospital                    Hotel

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

 

Required:

 

  1. Compare and contrast the use of absorption costing and ABC costing

to charge overheads to output

(8 marks)

  1. Calculate the overhead absorption rate for laundry and transport

and the overhead charged to each contract

(5 marks)

  1. Calculate the cost driver rate and the overhead cost charged to

each contract using ABC costing

(17 marks)

  1. 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.

(5 marks)

Total 35 marks