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A business manufactures refrigerators for domestic use. There are three models: Lo, Mid and Hi. The models, their quality and their price are aimed at different markets.
Product costs are computed on a blanket (business-wide) over head rate basis using a labour hour method. Prices as a general rule are set based on cost plus 20 per cent. The following information is provided:
LO Mid Hi
Material Cost(£/unit) 25 62.5 105
Direct labor hours per unit ½ 1 1
Budget production/sales(units) 20,000 1,000 10,000
The budgeted overheads for the business amount to £ 4,410,000.Direct labor is costed at £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 this problem an activity based costing approach has been suggested. The over heads are examined and these are grouped around main business activities of machining (£ 2,780,000) logistics £ 590,000 and establishment £ 1,040,000 costs. It is maintained that these costs could be allocated based respectively on cost drivers of machine hours, material orders and space to reflect the use of resources in each of these areas. After analysis the following 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
1. Calculate for each product the full costing and selling price determined by
The original costing method and the activity costing method
What are the implications of the two systems of costing in the situation given
What business/strategic options exist for the business in the light of the new information
