The solving process of question 2 Question 2 (30 marks) Home Design Ltd (\'Home\

Question

The solving process of question 2 Question 2 (30 marks) Home Design Ltd ('Home') is an interior design firm that provides professional services to clients including home decoration design, construction administration and furnishing The firm's costing system includes only labor and overhead costs. Home categorized its labor cost into 'professional' and back-office support'. These labor costs are allocated to design projects on the basis of hours worked by the professional and back-office staff according to the respective labor rates. The allocation base of overheads to projects is total labor hours worked In order to better evaluate the profitability of each design project, the firm is considering implementation of an activity based costing (ABC) system to allocate overheads. Home identified the following overhead activities, cost drivers and budgets Activity Cost Driver Budget 200,000 600,000 Planning Site scope Construction administration and furnishing Back-office support Number of planning meeting Number of site visit Number of work order Back-office labor hour 550,000 150,000 Professional staff cost Back-office staff cost Professional staff hour Back-office staff hour Number of planning meeting Number of site visit Number of work order $ 2,000,000 $ 800,000 3,200 hours 5,000 hours 400 1,000 1,000 The following are data relating to two projects completed by Home: Monterey Oasis

Explanation / Answer

a) The overhead rates for existing system:

professional labour rate = 2000000 / 3200 = $625

back office labour rate = 800000 / 5000 = $160

Overhead rate = 2800000 / 8200 = $341.5

i) Cost of projects using the current costing system

ii) Activity rates in ABC costing

b) Under the existing costing system, both Monetary and Oasis have lower costs as compared to the costs under activity based costing. This means the costs are underapplied under the existing costing system.

c) Under the ABC system, the overheads have been allocated on the basis of the respective cost drivers for the activities. This has resulted in directly identifying the reasons of the occurence of such overheads. The company can analyse the cost drivers which are expensive in relation to the other drivers and the costs can be studied in relation to these cost drivers.

d) Limitations of ABC include the following:

i) It is a very expensive costing system as it requires accumulation of a lot of data

ii) The data under ABC can be easily misinterpretated.

iii) Reports under the ABC system do not adhere to the general accepted accounting principles (GAAP)

Monetary Oasis Professional staff cost $1,87,500 $3,12,500 Back office cost $13,600 $14,400 Planning $2,049 $3,415 Site scope $3,415 $40,976 Construction admin and furnishing $6,829 $30,732 Contract service fee 280000 450000 Total cost $4,93,393 $8,52,022

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