A business manufacturers refrigerators for domestic use. There are 3 models: Lo, Mid and Hi. The models, their quality and their price are aimed at different markets. Product costs are computed on a blanket (businesss-wide) overhead rate basis using a labour-hour method. Price as a general rule are set based on cost plus 20%. The following information is provided:
Lo Mid Hi
Material cost (GBP/unit) 25 62,5 105
Direct labour hours (per unit) 1/2 1 1
Budget production/sales (units) 20,000 1,000 10,000
The budget overheads of the business amounts to GBP 4,410,000. Direct labor is costed at GBP 8 an hour. The business is currently facing increasing competition especially from imported goods. As a result the selling price of Lo has been reduced to a level that produces a very low profit margin. To address the problem an activity-based costing approach has been suggested. The overheads are examined and these are grouped around main business activities of machining (GBP 2,780,000), logistics (GBP 590,000) and establishment (GBP 1,040,000) costs. It is maintain that these costs can be allocated based respectively on cost drivers of machine hours, materials ordered and space to reflect the use of resources in each of these areas. After analysis the proportionate statistics are available in relation to the total volume of products.
Lo Mid Hi
% % %
Machine hours 40 15 45
Material orders 47 6 47
Space 42 18 40
As the management accountant for this business, you have been asked by your boss to compute two separate costs for each line of refrigerator and then complete a detailed analysis.
After you have read the information provided in the textbook, complete the following:
- Calculate for each product the full cost and selling price determined by:
- The original costing method
- The activity-based costing method
Once you have the figures computed, prepare a detailed report for your boss that includes a discussion of the following information:
- An analysis of implications involved with each of the two costing systems and subsequent price differences.
- An analysis of each costing system, including a recommendation of which cost system you would recommend or any changes you would suggest to the pricing strategy.
- An analysis of the business/strategic options that exist for your organisation in light of the new information, including possible pricing strategies.
The assignment should be prepared as a concise business report to your supervisor that includes both the figures computed and the analysis of the situation. Your written report should be approximately 2–3 pages in length; detailed quantitative comparisons and analyses can be attached in appendices.