A company xyz founded 9 years ago, produces four different products , Red, Orange, Yellow and Blue. The production manager is not happy with the cost management accounting system. He thinks its defective and refuses the figures. He is not happy with the CEO of the company for removing the blue product from production. The profit analysis created by the company controller was the reason the CEO decided to remove the blue product.

Direct material and direct labour are shared between each Red, Orange, Yellow and Blue on a 10/10/20/60 split respectively. The company had no inventory at the end of the previous year and expects to have no inventory of any product at the end of the year.

The company controller makes decisions about production management using information from quarterly reports and uses traditional costing practices. He refuses any questioning of his figures due to his qualifications in accounting and thinks this practice is the best based on the numerous accounting books he has read. Direct labour hour basis is used to charge manufacturing overheads in the traditional costing method.

Using traditional costing methods:

	Red	Orange	Yellow	Blue
Cost per Unit	1	1	1	3

Product	Projected Sales	Costs	Projected Profits
Red	410,400	342,000	68,400
Orange	376,200	342,000	34,200
Yellow	957,600	684,000	273,600
Blue	2,052,000	2,052,000	0
Total	3,796,200	3,420,000	376,200

He breaks down the overheads into different categories: The production manager will not accept the removal of the blue product so he contacts a friend who is a controller in a different company. The friend suggests ABC (activity based costing) method for identification of costs of the products.

Overhead Cost Pool	Cost Driver	Driver Rate(in ) = Cost / Total Driver Volume
Purchasing	Purchase Order	200
Machine setups for production runs	Production run setups	250
Material handlings	Material handlings	30
Machine depreciation	Machine hours	12
Facility rent	Size in square feet	15
Other manufacturing overhead	Machine hours	2.278571429

Using ABC costing methods:

	Red	Orange	Yellow	Blue
Cost per Unit	1.49	0.84	1.52	2.31

Product	Projected Sales	Costs	Projected Profits
Red	410,400	510,925	-100,525 (loss)
Orange	376,200	288,425	87,775
Yellow	957,600	1,042,300	-84,700 (loss)
Blue	2,052,000	1,578,350	473,650
Total	3,796,200	3,420,000	376,200

Question 1: What are the issues and challenges which have caused the inaccuracy of costs in a company? Also, has the company benefitted from using ABC costing instead? Explain how and to what extent.

Question 2: Provide a detailed analysis of the relative strengths and weaknesses of traditional absorption costing and ABC.

Question 3: What type of organisational conditions is needed in the company for ABC system to be utilized successfully? Currently, how suitable is this company's circumstances to achieve the ABC system successfully?