A language college teaches English as a Foreign Language. It has two departments: E (European mother tongue) and A (Asian mother tongue). Information about each is shown in Table 4.7. The overhead cost of cleaning classrooms is £32,000 per year.
Table 4.7 Information for Example 1: departments E and A
|
Department |
E |
A |
|
Number of teaching staff |
12 |
18 |
|
Annual teaching labour cost |
£600,000 |
£1,000,000 |
|
Number of rooms |
18 |
16 |
The traditional method of allocating cleaning overhead cost to departments has been to apply a rate of two per cent of the labour cost of teaching. This is shown in Table 4.8.
Table 4.8 Traditional treatment of cleaning overhead
|
|
E |
A |
|
Overhead cost rate |
2% of labour cost |
2% of labour cost |
|
Apportionment of cost £32,000 |
£12,000 |
£20,000 |
The head tutor of Department A feels this is unfair because it has fewer classrooms than Department E and so requires less cleaning effort. Assume that cleaning cost may be regarded as a cost pool and show how activity based costing can be applied where the number of classrooms is the cost driver for cleaning. The apportionment of cost by the activity based method is shown in Table 4.9.
Table 4.9 Activity based costing for cleaning overhead
|
|
E |
A |
|
Cost pool: cleaning, £32,000 |
|
|
|
Cost driver: fraction of classroom usage |
18/34 |
16/34 |
|
Apportionment of cost £32,000 |
£16,940 |
£15,060 |
Comment. The head of Department A will be happier with the use of activity based costing because it reflects the lower usage of cleaning driven by fewer classrooms. On the other hand, it may be that this is not the best cost driver. For instance, suppose that the head of Department E responds by pointing out that their classrooms are kept tidy and are therefore easier to clean. The debate over cost drivers might take some time to resolve.