Zafar Syed
Sep 1, 2009, 10:35 PM
Challenging Activity based costing problem( Please copy this in word and then solve)
Ace appliances is a division of camforth co. Ace Appliances produce two models of automatic washing machines to be sold to house hold appliance retailers. The supermodel has been produced since 2001 and sells for $900. The deluxe is a newer model which was introduced in 2005 and sells for $1140. On analysing the following income statement for the year ended March 2006, the senior management team of Ace appliances have decided to concentrate Ace appliances resources on the deluxe model and to stop prodn of super model.
Ace appliances
Income statement for the year ended March 2006
Unit sales super ( 22000 units) Deluxe(4000 units) Total
$000 $000 $000
Sales 19800 4560 24360
cost of goods sold 12540 3192 15732
gross profit 7260 1368 8628
selling and admin exp 5830 978 6808
Net profit 1430 390 1820
Unit costs for super and deluxe were as follows
Super Deluxe
$ $
Direct material 208 584
Direct labour
Super(1.5 hrs X$12) 18
Deluxe (3.5X $12) 42
Machine cost
Super(8 machine hours X 18$) 144
Deluxe (4 machine hrsX$18) 72
Manufacturing overheads 200 100
(other than machine costs) __________________________
Total cost per unit 570 798
1 Machine costs include depreciation costs of the machinery, repairs and maintenance.
2 Manufacturing overheads were allocated to product based on machine hours at the rate 25$ per hr.
Ace appliances financial controller, David Wong is recommending the use of activity based costing and has collected the following information about the company’s manufacturing costs for the year ending March.2006
Activity center Total activity Units of the cost allocation base
Cost allocation base Costs$ Super Deluxe Total
Soldering 942,000
No of soldering points 1,185,000 385,000 1,570,000
Shippments 860,000
No of shippments 16,200 3,800 20,000
Quality control 1,24,000
(No of inspections) 56200 21300 77500
Purchase orders 950400
No of orders 150,020 40,060 190,080
Machine power 57600
Machine hours 176000 16000 192000
Machine set up 750000
No of set up 16000 14000 30000
Tot mfg overheads 4,800,000
After completing his analysis, David showed the results to the Ace appliances CEO Tom Ford. Tom was not at all pleased with the projected figures. If you show this analysis to head office, they are going to stop making the deluxe model which we have only just introduced’ this costing in general has been a major problem for us. First super was not profitable and now the deluxe
Looking at the ABC analysis I see two problems
First we have many more activities than the ones you have listed. If you had included all of the activities may be your conclusion would be different
Secondly you used number offset ups and number of inspections as allocation bases instead I know the measurement problems prevent you from using these other allocation basis but I believe you ought to make some changes to our current numbers to compensate for these issues. I know you can do better; we cannot afford to phase out either product.
David knows his numbers are fairly accurate. On a limited sample he calculated the profitability of super and deluxe using more and different allocation basis.
The set of activities and activity rates that he used resulted in numbers that were very close to those based on more detailed analysis. He is confident that the head office knowing that deluxe was introduced only recently will not ask Ace appliances to phase it out. He is also aware that a sizeable portion of Tom’s bonus is based on the division’s sales revenue. Stopping either product would affect his bonus. However he does feel some pressure from Tom to do something.
I have solved the questions a and b please verify if the answer is correct then please help me by solving the remaining questions
Required:
a) Using activity based costing calculate the profit of the super and deluxe model( ABC relates to only the manufacturing overheads)
b) Explain briefly why these numbers differ from the profits of the two models using the income statement figures as given at the beginning of the problem
c) All the cost allocation bases ( activity measures or cost drivers except machine power used in theaboveABC analysis are transaction drivers i.e simple counts of the number of times an activity occurred. Explain briefly the difference between the transaction drivers and duration drivers. Why did David Wong use the transaction drivers instead of duration drivers ( Please suggest a detailed answer)
d) Briefly comment on Tom Fords concerns about the accuracy and limitations of activity based costing
e) Discuss the importance of choosing appropriate cost drivers in the case study described above ( Please suggest a detailed answer)
f) What factors would have motivated David Wong to resort to Activity based costing ( Please suggest a detailed answer)
A) Calculations of profit of the super and deluxe models
Calculations for average overhead cost per unit:
Activity Rate per unit of cost driver
($) Activity cost assigned to super ($) Activity cost assigned to deluxe
($)
Soldering 0.6
(942,000/157,000)
71,1000
(0.6X1,185,000) 2,31,000
(0.6X385000)
Shipments 43
(860,000/20,000)
696,600
(43X16,200) 163,400
(43X3,800)
Quality control 16
(1240,000/77500)
899,200
(16X56,200) 340,800
(16X21,300)
Purchase Orders 5
(950,000/190,080)
750,100
(5X150,020) 200,300
(5X40,060)
Machine Power 0.30
(57,600/192,000)
52800
(0.30X176,000) 4800
(0.30X16000)
Machine setups 25
(750,000/30,000)
400,000
(25X16000) 350,000
(25X14000)
Total manufacturing cost
3,509,700
1,290,300
No of units sold 22,000 4,000
Unit manufacturing cost *159.53
(3,509,700/22000) *322.58
(1,290,300/4000)
Calculation of profits:
ACE APPLIANCES
INCOME STATEMENT FOR THE YEAR ENDING 31ST MARCH,2006 USING ACTIVITY BASED COSTING
Particulars Super ($) Deluxe ($)
Sales 19,800,000
(22000X900)
4,560,000
(4000X1140)
Less: Cost of goods sold 11,649,660
(22000X*159.53)
1,290,320
(4000X*322.58)
Gross profit 8,150,340 3,269,680
Less: Selling and Administrative cost 5,830,000
(22000X *265
*(5830/22000)X1000
978,000
(4000X *244.50)
*(978/4000)X1000
Net profit 2,320,340 2,291,680
b) In order to find why the figures differ from the profit of the two models let us ascertain and compare the unit cost by using the traditional based and Activity based costing(Income statement figures)
Particulars Super model ($) Deluxe model ($)
Traditional Activity based Traditional Activity based
Direct Material 208.00 208.00 584.00 584.00
Direct labour 18.00 18.00 42.00 42.00
Machine cost 144.00 144.00 72.00 72.00
Manufacturing
Overheads 200.00 159.53 100.00 322.58
Total cost per unit 570.00 529.53 798.00 1020.58
Selling&admn exp per unit 265 265 244.50 244.50
Total 835.00 794.53 1042.50 1265.08
As can be seen the cost of manufacturing overheads by way of traditional method and the activity based costing method are different hence the difference.
Ace appliances is a division of camforth co. Ace Appliances produce two models of automatic washing machines to be sold to house hold appliance retailers. The supermodel has been produced since 2001 and sells for $900. The deluxe is a newer model which was introduced in 2005 and sells for $1140. On analysing the following income statement for the year ended March 2006, the senior management team of Ace appliances have decided to concentrate Ace appliances resources on the deluxe model and to stop prodn of super model.
Ace appliances
Income statement for the year ended March 2006
Unit sales super ( 22000 units) Deluxe(4000 units) Total
$000 $000 $000
Sales 19800 4560 24360
cost of goods sold 12540 3192 15732
gross profit 7260 1368 8628
selling and admin exp 5830 978 6808
Net profit 1430 390 1820
Unit costs for super and deluxe were as follows
Super Deluxe
$ $
Direct material 208 584
Direct labour
Super(1.5 hrs X$12) 18
Deluxe (3.5X $12) 42
Machine cost
Super(8 machine hours X 18$) 144
Deluxe (4 machine hrsX$18) 72
Manufacturing overheads 200 100
(other than machine costs) __________________________
Total cost per unit 570 798
1 Machine costs include depreciation costs of the machinery, repairs and maintenance.
2 Manufacturing overheads were allocated to product based on machine hours at the rate 25$ per hr.
Ace appliances financial controller, David Wong is recommending the use of activity based costing and has collected the following information about the company’s manufacturing costs for the year ending March.2006
Activity center Total activity Units of the cost allocation base
Cost allocation base Costs$ Super Deluxe Total
Soldering 942,000
No of soldering points 1,185,000 385,000 1,570,000
Shippments 860,000
No of shippments 16,200 3,800 20,000
Quality control 1,24,000
(No of inspections) 56200 21300 77500
Purchase orders 950400
No of orders 150,020 40,060 190,080
Machine power 57600
Machine hours 176000 16000 192000
Machine set up 750000
No of set up 16000 14000 30000
Tot mfg overheads 4,800,000
After completing his analysis, David showed the results to the Ace appliances CEO Tom Ford. Tom was not at all pleased with the projected figures. If you show this analysis to head office, they are going to stop making the deluxe model which we have only just introduced’ this costing in general has been a major problem for us. First super was not profitable and now the deluxe
Looking at the ABC analysis I see two problems
First we have many more activities than the ones you have listed. If you had included all of the activities may be your conclusion would be different
Secondly you used number offset ups and number of inspections as allocation bases instead I know the measurement problems prevent you from using these other allocation basis but I believe you ought to make some changes to our current numbers to compensate for these issues. I know you can do better; we cannot afford to phase out either product.
David knows his numbers are fairly accurate. On a limited sample he calculated the profitability of super and deluxe using more and different allocation basis.
The set of activities and activity rates that he used resulted in numbers that were very close to those based on more detailed analysis. He is confident that the head office knowing that deluxe was introduced only recently will not ask Ace appliances to phase it out. He is also aware that a sizeable portion of Tom’s bonus is based on the division’s sales revenue. Stopping either product would affect his bonus. However he does feel some pressure from Tom to do something.
I have solved the questions a and b please verify if the answer is correct then please help me by solving the remaining questions
Required:
a) Using activity based costing calculate the profit of the super and deluxe model( ABC relates to only the manufacturing overheads)
b) Explain briefly why these numbers differ from the profits of the two models using the income statement figures as given at the beginning of the problem
c) All the cost allocation bases ( activity measures or cost drivers except machine power used in theaboveABC analysis are transaction drivers i.e simple counts of the number of times an activity occurred. Explain briefly the difference between the transaction drivers and duration drivers. Why did David Wong use the transaction drivers instead of duration drivers ( Please suggest a detailed answer)
d) Briefly comment on Tom Fords concerns about the accuracy and limitations of activity based costing
e) Discuss the importance of choosing appropriate cost drivers in the case study described above ( Please suggest a detailed answer)
f) What factors would have motivated David Wong to resort to Activity based costing ( Please suggest a detailed answer)
A) Calculations of profit of the super and deluxe models
Calculations for average overhead cost per unit:
Activity Rate per unit of cost driver
($) Activity cost assigned to super ($) Activity cost assigned to deluxe
($)
Soldering 0.6
(942,000/157,000)
71,1000
(0.6X1,185,000) 2,31,000
(0.6X385000)
Shipments 43
(860,000/20,000)
696,600
(43X16,200) 163,400
(43X3,800)
Quality control 16
(1240,000/77500)
899,200
(16X56,200) 340,800
(16X21,300)
Purchase Orders 5
(950,000/190,080)
750,100
(5X150,020) 200,300
(5X40,060)
Machine Power 0.30
(57,600/192,000)
52800
(0.30X176,000) 4800
(0.30X16000)
Machine setups 25
(750,000/30,000)
400,000
(25X16000) 350,000
(25X14000)
Total manufacturing cost
3,509,700
1,290,300
No of units sold 22,000 4,000
Unit manufacturing cost *159.53
(3,509,700/22000) *322.58
(1,290,300/4000)
Calculation of profits:
ACE APPLIANCES
INCOME STATEMENT FOR THE YEAR ENDING 31ST MARCH,2006 USING ACTIVITY BASED COSTING
Particulars Super ($) Deluxe ($)
Sales 19,800,000
(22000X900)
4,560,000
(4000X1140)
Less: Cost of goods sold 11,649,660
(22000X*159.53)
1,290,320
(4000X*322.58)
Gross profit 8,150,340 3,269,680
Less: Selling and Administrative cost 5,830,000
(22000X *265
*(5830/22000)X1000
978,000
(4000X *244.50)
*(978/4000)X1000
Net profit 2,320,340 2,291,680
b) In order to find why the figures differ from the profit of the two models let us ascertain and compare the unit cost by using the traditional based and Activity based costing(Income statement figures)
Particulars Super model ($) Deluxe model ($)
Traditional Activity based Traditional Activity based
Direct Material 208.00 208.00 584.00 584.00
Direct labour 18.00 18.00 42.00 42.00
Machine cost 144.00 144.00 72.00 72.00
Manufacturing
Overheads 200.00 159.53 100.00 322.58
Total cost per unit 570.00 529.53 798.00 1020.58
Selling&admn exp per unit 265 265 244.50 244.50
Total 835.00 794.53 1042.50 1265.08
As can be seen the cost of manufacturing overheads by way of traditional method and the activity based costing method are different hence the difference.