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Tutorial Document and Self Assessment Questions
Tutorial 3 Strategic Management Accounting Techniques – ABC/M,
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Aim
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1. To consider how activity-based costing can help management understand the key cost drivers 2. To consider pricing and cost-related prioritisation of organisational activities. |
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Reading |
Bhimani et al. Chapters 11 and 22 in the recommended text |
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Self assessment |
Complete the multiple choice questions for chapters 11 and 22 page 695-699
Consider the end-of-chapter review questions for chapters 11 and 22
Attempt end-of-chapter exercises:
11.11 ABC and product cross-subsidisation and and 11.12 ABC, activity area and cost driver rates (Solution in Appendix A) 11.13 ABC and product cross-subsidisation
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Tutorial Activities and Questions |
Attempt
Below questions |
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1. BML has three product lines P1, P2 and P3. Since its creation the company has been using a single direct labour cost percentage to assign overhead costs to products.
Despite P3, a relatively new line, attracting additional business, increasing overhead costs and a loss of market share particularly for P2 a major product, have convinced the management that the costing system is in need of some development. A team, led by the management accountant, was established to develop an improved system of costing based on activities. The team spent several weeks collecting data (see tables below) for the different activities and products. For the accounting period in question, given in the tables below is data on BML’s three product lines and the overhead costs applicable to them:
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Activities |
Overhead cost |
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£ |
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Material receiving |
50,000 |
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Machine maintenance |
30,000 |
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Set-up labour |
18,688 |
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Material handling |
100,000 |
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Engineering |
100,000 |
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Packing |
60,000 |
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Machine depreciation |
360,000 |
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Total |
718,688 |
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P1 |
P2 |
P3 |
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Production volume |
7,500 units |
12,500 units |
4,000 units |
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Direct labour cost per unit |
£4 |
£8 |
£6.4 |
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Material cost per unit |
£18 |
£25 |
£16 |
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Selling price per unit |
£47 |
£80 |
£68 |
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Materials movements (in total) |
4 |
25 |
50 |
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Machine hours per unit |
0.5 |
0.5 |
0.2 |
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Set-ups (in total) |
1 |
5 |
10 |
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Proportion of engineering work |
30% |
20% |
50% |
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Orders packed (in total) |
1 |
7 |
22 |
Required
(a) Calculate the overhead rate and the product unit costs under the existing costing system.
(b) Identify for each overhead activity cost pool, an appropriate cost driver from the information supplied and then calculate the product unit costs using a system that assigns overheads on the basis of the use of activities.
(c) Comment on the results of the two costing systems in (a) and (b) above.
2. Case study: AKO Electronic
AKO Electronics has been at the forefront of hi-tech products in Britain since the information technology explosion of the 1970s. From modest premises in the Chelmsford suburbs, founder and now Chief Executive, Rick Pitts, has driven the company to a respected position among leaders in the market, with a reputation for meeting consumer needs. Rick’s genius has always been in providing products in anticipation of the market and in bringing those products in ahead of competitors. Costing and pricing have always been much lower on his priorities because new, well-marketed products have always been successful.
The management at AKO is now worried. The company’s bottom-line displays a disconcerting downturn for the second successive year-the first time this has happened in a 20 year history. This relatively poor performance is largely attributable to lack of sales revenue stemming from an inexplicable failure to win orders in competitive tenders. The Chief Executive feels that the pricing policies must be wrong and has called for a full investigation of current procedures in order to identify deficiencies. AKO has always prided itself on staying at the cutting edge of new marketing opportunities. The company reckons itself to be the most efficient producer worldwide of its two traditional products, (A) and (B), electronic calculators whose sophistication almost places them in the category of mini-computers. Both are mature and proven products with the latter recently upgraded to accommodate a series of statistical functions. AKO has recently marketed two further products, the (C) screen-enhancer for lap-top computers and the (D), a memory-conserving PC add-on. The success of the new products has surprised even the most optimistic members of management.
Although the new products have been successfully launched, it is the sales of the traditional products which are the greatest cause of concern. AKO has failed to win orders that it fully expected to win, and worse still, it has lost out to competitors that it views as inferior and less efficient. Inferior producers have been able to tender at more competitive prices, suggesting that there is something wrong with pricing procedures at AKO. Each of the products proceeds through the same four-stage production process, though the time spent and resources consumed at each stage vary between products:
STAGE 1 – Supply of raw material components;
STAGE 2 – set-up and run of production engineering;
STAGE 3 – vacuum packing of finished product;
STAGE 4 – distribution of product to wholesalers and retailers
The table below shows the monthly cost information which is employed by AKO in its current pricing procedures:
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Total |
Total |
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A |
B |
C |
D |
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Units of product Resources per unit: Raw Materials Labour Hours Machine Hours Production Costs per unit: Raw Materials Direct Labour Overheads Machining (per hour) Engineering set-ups in total Component receipts in total
Orders packaged in total Distribution deliveries in total |
30,000
4 1 1
£12 £8
£10 3 20
10 10 |
20,000
5 2 1
£15 £16
£10 7 40
2 10 |
8,000
10 1.25 2.5
£30 £10
£10 20 240
20 25 |
10,000
15 1 1
£45 £8
£10 10 100
18 20 |
68,000
450,000 90,000 80,000
£1,350,000 £720,000
£800,000 £40,000 £400,000
£300,000 £260,000 |
Prices are currently calculated with respect to unit costs computed on the basis of direct labour, direct material and a share of overhead costs. Overheads are allocated on the basis of direct labour hours (DLH) using an overhead rate of 1,800,000/90,000 = £20 per DLH. The calculation of selling prices for each of the products is shown below:
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Product |
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A |
B |
C |
D |
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Direct Labour (£) Direct Materials (£) Allocated Overhead (£) |
8.0 12.0 20.0 |
16.0 15.0 40.0 |
10.0 30.0 25.0 |
8.0 45.0 20.0 |
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Total Cost (£) Mark-up (50%) (£) |
40.0 20.0 |
71.0 35.5 |
65.0 32.5 |
73.0 36.5 |
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Selling Price (£) |
60.0 |
106.5 |
97.5 |
109.5 |
Required
To examine the current method of establishing product costs and prices and makes recommendations for an improved system. Your analysis should include a consideration of the impact on prices of alternative cost bases and of alternative methods of allocating costs to products.