ABC Ltd manufactures two products, the Simplex and the Complex. The Simplex has been produced and sold for some years, and although it is a well-established brand it has been losing market share in recent years to cheaper products from competitors. The Complex, on the other hand, is a new product that was introduced about six months ago. ABC Ltd is excited about the Complex, as it has been well received by the market and sales have increased steadily since its launch. In fact, the company is thinking of phasing out production of the Simplex and putting all of its efforts behind the Complex.

Monthly cost, production and sales data relating to the products are as follows:

Complex Simplex
Direct material cost per unit £150.00 £55.00
Direct labor cost per unit 30.00 20.00
Total direct costs per unit £180.00 £75.00

Direct labor hours per unit 1.5 hours 1.0 hour
Selling price per unit £913.50 £546.00
Monthly sales units 100 units 900 units

At present the company uses a traditional method of overhead absorption. Manufacturing overheads amount to £330,750 per month, and are absorbed by the two products on the basis of direct labour hours. The company uses a cost-plus method of pricing, with prices for both products being based on the full production cost per unit, plus 40%. The company also employs a just-in-time inventory policy, so that there are no monthly opening or closing inventories of WIP or finished goods.

ABC Ltd is planning to introduce an activity-based costing (ABC) system. The company has identified the activities which are required each month to produce the sales volumes of the two products, as indicated above, and has also determined the overhead activity cost pools and activity cost drivers for each cost pool. The results of this analysis are presented below:

Required:

1) Using the same mark-up as before, re-calculate the selling price of each product if ABC was used to determine product costs.

2) Why might the Simplex be losing market share, and why might sales of the Complex be growing? Explain briefly, using insights gained from your ABC analysis.

3) Would it be wise for ABC Ltd to start phasing out production of the Simplex so as to concentrate on the Complex? Briefly advise the company, with reasons, why this might or might not be a good idea.

Activity Total Overhead Cost (s) Cost Driver Total number Setting-up machinery Machining Assembly Quality Control No. of set-ups Machine hours 66,000 126,150 99,000 39,600 330,750 33 2.523 4,400 1,000 No. of components Inspection hours Activity cost driver units required by the two products are: Cost Driver Total number Complex Simplex No. of set-ups 33 25 2,000 3,600 No. of machine hours 2,523 4,400 1,000 523 No. of components No. of inspection hours 800 200 800