Arab Open University B292: TMA – Spring Semester 2016 Cut-Off Date: May 5, 2016 About TMA: The TMA covers the management accounting concepts and practices in the businesses. It is marked out of 100 and is worth 20% of the overall assessment compo

Arab Open University
B292: TMA – Spring Semester 2016
Cut-Off Date: May 5, 2016

About TMA:
The TMA covers the management accounting concepts and practices in the businesses. It is marked out of 100 and is worth 20% of the overall assessment component. It is intended to assess students’ understanding of one of the important concepts in management accounting which has emerged as an alternative to traditional costing methods. In recent years the nature of industrial production has fundamentally altered as it became more capital intensive and based on machine production, overheads tend to be more dominant and the international market became highly competitive. This TMA requires you to apply the course concepts. The TMA learning objectives are intended to:

 Enhance student ability to understand the calculation of traditional and activity –based costing.
 To exemplify the benefits and drawbacks of activity based costing.
 To recognize the greater accuracy of ABC for manufacturers with products demanding varying overhead expenses
 To reinforce the cost benefits of effective management decision making.
 Assess students’ understanding of key learning points within units 2, 3 & 4.
 Increase the students’ knowledge about the reality of the Managerial Accounting as a profession.
 Develop students’ communication skills, such as memo writing, essay writing, analysis and presentation of material.
 Develop the ability to understand and interact with the nature of the managerial accounting tools in reality.


The TMA requires you to:
1- Review various study sessions beside the supplementary materials.
2- Conduct a simple information search using the internet.
3- Present your findings in not more than 2,000 words ± 10%.
4- You should use a Microsoft Office Word/excel and Times New Roman Font of 12 points.
5- You should read and follow the instructions below carefully. Each part of the process will carry marks for the assignment.








Criteria for Grade Distribution:
Criteria Content Referencing
(to deduct) Structure and Presentation of ideas
(to deduct) Total marks
Part A Part B
Computations Analysis
Marks 60 40 (5) (5) 100


Case Overview

The Management at DELTA Corporation, a midsize Toy manufacturing firm had become aware of the ongoing imbalance between the product’s budgeted and actual costs. The DELTA Corporation normally allocated overhead to products using a single direct cost driver usually direct labor hours or direct labor dollars. This practice sometimes led to inaccuracies, since indirect costs were not incurred equally across products. For example DELTA’s CFO had forecasted $10,000,000 in direct labor costs and $ 15,000,000 in overhead for a particular project last year, resulting in an overhead rate of 150 per cent. For each dollar of direct labor charged $ 1.50 of overhead had been allocated. The short coming of this costing method was that overhead costs failed to reflect varying manufacturing intensity between products.
Often referred to as smoothing, traditional costing allocates overhead costs evenly per direct labor hours or dollars. Unfortunately, direct costing can result in a discrepancy between the budgeted overhead and the actual overhead used. Often, certain products require more maintenance or floor space. Traditional costing allocates overhead based on direct expenses without compensating for a product’s greater or lesser use of overhead costs.
Activity-based costing (ABC) was first introduced in the United States during the 1970s. Since then ABC had enjoyed wide acceptance as a more accurate alternative to traditional costing especially in manufacturing. Instead of budgeting overhead using direct cost drivers, ABC splits overhead into activity cost drivers leading to a more tangible assignment of costs.




Calculating ABC is more complicated than calculating traditional costing. Once management identifies the activity cost drivers, overhead rates are assigned per cost driver. The rates are estimated by dividing budgeted costs per driver by the anticipated resource requirements for each cost driver. For instance, rent could be allocated based on the square footage occupied by inventory in producing a given product or service. Say X Company estimates next year’s rental costs to be $ 30,000 for its 15,000-square-foot factory. X Company can calculate the rental overhead rate by dividing $30,000 by 15,000 to get 2. After calculating the overhead rates for each activity driver (rent, depreciation, maintenance, etc...) the rates are applied to the individual requirements of each product. Continuing the previous example, suppose X Company manufactures two products, Y and Z requiring 10,000 and 5,000 square feet of factory space respectively. X Company can calculate each product’s individual use of factory rent by multiplying 10,000 and 5,000 by 2, resulting in $ 20,000 for Y and $ 10,000 for Z.
The objective of ABC is to align actual consumption with specific product/service costs. A benefit of ABC is that products requiring higher concentrations of overhead costs are revealed allowing management to focus attention on opportunities for reducing those costs or to price more appropriately.
Activity-based costing allocates overhead to a product based on the actual amount of overhead used by that product. ABC can be equally valuable in service industries. Financial institutions have diverse products and customers resulting in cross-product, cross-customer subsidies. Often, personnel expense represents the largest single component of non-interest expense in financial institutions. Accordingly, these costs must also be attributed more accurately to products and customers via activity-based accounting.


The ABC methodology is an involved process with many steps including identifying direct product costs, identifying cost activities, selecting cost-allocation basis (CAB), identifying indirect costs per CAB , computing overhead rate per cost activity, calculating overhead costs based upon each product’s use of the various cost activities and then adding direct expenses and indirect expenses to yield total product costs. Despite the complexity, the benefits of ABC can be significant: management can distinguish profitable from unprofitable products, cost controls can be established to eliminate unnecessary costs, and products can be better priced. However, prior to implementing ABC, management should consider whether the cost savings from more accurate budgeting are greater than the research costs of identifying overhead cost driver and each products’ individual resource requirements.
Delta’s Situation
The DELTA Corporation made four products Nana, Ruby, Dony and Fony. Table 1 summarizes the direct labor, overhead and direct material costs associated with these products.
DELTA management was considering implementing an activity-based costing system as a means of improving product pricing. Table 2 presents the cost allocation bases for the three main overhead cost drivers (depreciation, set-up, and rent). Table 3 shows the product resource requirements by cost driver. Notice for example, that the set-up requirement for NANA is 200 hours.



The TMA questions

The CFO wants you to aid him in this analysis & to compare the overhead estimates per product based on the traditional costing and ABC methods. In addition the CFO wanted to understand / compute the following:
Part A(60 marks)
1. Use the traditional costing method to compute the overhead costs per product and also the total costs per product.(20 marks)
2. Using ABC.
a. Calculate the activity-based overhead rates per activity cost driver(10 marks)
b. For each product ,compute the overhead costs per activity cost driver(15 marks)
c. Using the overhead costs from b, calculate the total costs per product.(15 marks)
Part B(40 marks-distributed equally)
3. Assuming ABC allocated overhead more accurately, which products were incorrectly priced using traditional costing method? What difficulties might result from incorrectly budgeted products?
4. What actions might be explored to deal with the mispriced products?
5. Compare assigned costs per product under both methods. Why had activity-based costing changed the total costs assigned to each product?
6. What were two circumstances where traditional and ABC costing would likely yield similar or equal overhead costs?








Table 1
DIRECT LABOR, OVERHEAD, AND DIRECT MATERIALS COSTS

Total direct labor $1,000,000
Total overhead $2,000,000
Overhead rate 200% of direct labor
NANA direct labor $100,000
RUBY direct labor $300,000
DONY direct labor $400,000
FONY direct labor $200,000
NANA direct material $100,000
RUBY direct material $200,000
DONY direct material $150,000
FONY direct material $250,000
Units built 1,000 of each product


Table 2
OVERHEAD COST DRIVERS
Cost allocation bases Total costs Quantity of CAB
Depreciation $ 300,000 3,000 machine hours
Set-up $ 700,000 1,000 set-up hours
Rent $1,000,000 100,000 square feet

Table 3
PRODUCT RESOURCE REQUIREMENTS BY COST DRIVER
NANA RUBY DONY FONY
500 machine hours 900 machine hours 400 machine hours 1,200 machine hours
200 set-up hours 300 set-up hours 100 set-up hours 400 set-up hours
20,000 square feet 30,000 square feet 10,000 square feet 40,000 square feet

End of TMA