Bradford Watch Company manufactures luxury and sports watches both for male and female customers. The luxury watches are famous for the high-end design materials while the sports watches are popular for their utilities. The company uses a traditional costing system in assigning overhead costs to the products on the basis of direct labour hours. However, the Production Manager seeks to replace the existing system with the Activity-based Costing (ABC) system to keep control over costs and offer more competitive pricing. After reviewing the existing costing system and interviewing the company’s personnel in relevant departments, the accountant compiled a report highlighting resources and costs involved in manufacturing watches per month: The following table lists out the overhead cost: Activity cost pool Overhead cost (£) Additional Notes Job-order set up 33,000 Procurement and placement 360,000 Installation of winding system 195,000 An auto winding system is fitted with every watch Quality inspection (machine) 60,000 Quality inspection (manual) 21,000 Finishing 140,000 Hand-made finishing Packaging and delivery 44,250 The company packages and delivers watches in batches containing 10 watches per batch. On an average, the packaging and delivery cost is the same for all batches (10 watches= 1 batch) Factory cleaning services 30,000 A cost that is not consumed by any of the products The company pays £8 per direct labour hour The following table lists out some key figures for this firm: Description Quantity Number of watches 1,500 units Direct labour hours 7,000 hours Machine hours 14,000 hours Number of job orders 110 Inspection hours using machine 800 hours Number of cycles for procurement and placement 2,400 times Required: a) Calculate the manufacturing overhead absorption rate using the traditional absorption costing system (3 marks) b) What would be the sales price of the following two products using the ABC system if the company adds 30% mark-up on total allocated costs?
Answer ALL FOUR questions.
Question 1
Bradford Watch Company manufactures luxury and sports watches both for male and female customers. The luxury watches are famous for the high-end design materials while the sports watches are popular for their utilities.
The company uses a traditional costing system in assigning overhead costs to the products on the basis of direct labour hours. However, the Production Manager seeks to replace the existing system with the Activity-based Costing (ABC) system to keep control over costs and offer more competitive pricing. After reviewing the existing costing system and interviewing the company’s personnel in relevant departments, the accountant compiled a report highlighting resources and costs involved in manufacturing watches per month:
- The following table lists out the overhead cost:
|
Activity cost pool |
Overhead cost (£) |
Additional Notes |
|
Job-order set up |
33,000 |
|
|
Procurement and placement |
360,000 |
|
|
Installation of winding system |
195,000 |
An auto winding system is fitted with every watch |
|
Quality inspection (machine) |
60,000 |
|
|
Quality inspection (manual) |
21,000 |
|
|
Finishing |
140,000 |
Hand-made finishing |
|
Packaging and delivery |
44,250 |
The company packages and delivers watches in batches containing 10 watches per batch. On an average, the packaging and delivery cost is the same for all batches (10 watches= 1 batch) |
|
Factory cleaning services |
30,000 |
A cost that is not consumed by any of the products |
- The company pays £8 per direct labour hour
- The following table lists out some key figures for this firm:
|
Description |
Quantity |
|
Number of watches |
1,500 units |
|
Direct labour hours |
7,000 hours |
|
Machine hours |
14,000 hours |
|
Number of job orders |
110 |
|
Inspection hours using machine |
800 hours |
|
Number of cycles for procurement and placement |
2,400 times |
Required:
- a) Calculate the manufacturing overhead absorption rate using the traditional absorption costing system
(3 marks)
- b) What would be the sales price of the following two products using the ABC system if the company adds 30% mark-up on total allocated costs?
|
Model |
Luxury |
Sports |
|
Category |
Female |
Male |
|
Job order number |
LF-340 & LF-341 |
SM-119 & SM-120 |
|
Number of units |
30 |
50 |
|
Direct materials (£ per unit) |
85 |
55 |
|
Direct labour hours |
200 |
250 |
|
Machine hours |
225 |
750 |
|
Inspection hours using machine |
12 |
40 |
|
Number of cycles for procurement and placement |
50 |
80 |
(10 marks)
- c) Given the value in a) and b), please brief explain the differences between traditional absorption costing approach and Activity Based Costing (ABC) approach.
(4 marks)
- d) Discuss how allocation of customer-related overhead cost can lead to better decision making within firms with reference to the case below.
‘An insurance company, A-Insure Limited, decided to use CPA to identify profitable and non-profitable customers after it grew concerned about the poor financial performance of one of its policy options. A-Insure collected customer data through original policy proposal forms which were stored electronically in a customer database. It was able to conduct a complex cross correlation between known cost drivers and the demographic and other characteristics of policy holders. The cost drivers were:
- commission payments to financial advisers who sold the policy
- early surrender of the policy by the policy holder
- changing of bank details and consequent chasing of missed premiums
- responding to customer queries.
The analysis identified that the policy was unprofitable when sold to recently retired clients but was profitable when sold to other client segments. Recently retired customers had more time to review and consider changes to their insurance policies and to make queries. In response, the company reduced agents’ commissions on the policies according to the age of the policyholder to discourage them from selling to the non-profitable client segment.
Most companies have a customer database that can be mined for information to identify customer segments. If companies do not have the software to perform detailed CPA, specialist software can be purchased from many business software vendors.’
Adapted from Botten, N (2006)
(5 marks)
Step by step
Solved in 2 steps with 2 images
