168 ACCOUNTING FOR MANAGERS
Table 11.6 Overhead per product based on ABC
Product A Product B
Total overhead £75,000 £25,000
Quantity produced 150 250
Per product (/100) £500 £100
We can then calculate the overhead cost per product/service by dividing the
total cost pool by the quantity of products/services produced. This is shown in
Table 11.6.
The prime cost (the total of direct costs) is not affected by the method of overhead
allocation. The total cost of each product using ABC for overhead allocation is
shown in Table 11.7. Table 11.8 compares the cost of each product calculated using
absorption costing with that using ABC.
Although this is an extreme example, significant differences can result from the
adoption of an activity-based approach to overhead allocation. In this example,
overheads allocated using direct labour hours under absorption costing do not
reflect the actual causes for overheads being incurred. Product A not only uses
more purchasing and production order activity (the drivers of overheads), but
also has a lower volume. Reflecting the cause of overheads in overhead allocations
more fairly represents the cost of each product. Under absorption costing, Product
B was subsidizing Product A. Cross-subsidization can be hidden where a business
sells a mixture of high-volume and low-volume products/services.
The distinction between fixed and variable costs and between production
overhead and non-production overhead that applies to absorption costing is not
so important under ABC. Costs under an ABC approach are identified as follows:
Table 11.7 Product costing under ABC
Direct
materials
Direct
labour
Manufacturing
overhead
Total cost
per table
Product A £110 £75 £500 £685
Product B £150 £50 £100 £300
Table 11.8 Comparison of product costs under absorption costing
and activity-based costing
Product A Product B
Total cost using absorption costing £489 £471
Total cost using activity-based costing £685 £300