ABC

Sally Ltd manufactures two types of radios: a standard model and a smaller portable model. The standard model sells for $35 and the portable for $24. The production costs calculated on a per-unit basis for each model this year were as follows:

Traditional Costing

Standard Portable

Direct materials $ 9.50 $ 6.00

Direct labour ($10 per hour) 8.00 5.00

Manufact. overhead ($17.08 per DLH) 13.66 8.54

Total per unit cost $31.16 $19.54

During the year, Cloud Ltd manufactured 50,000 standard radios and 20,000 portable radios. The overhead application rate of $17.08 per direct labour hour was determined by dividing the total expected manufacturing overhead of $854,000 by the total estimated direct labour hours (50,000) for the two models.

Under traditional costing, the per unit gross profits for the two models were as follows:

Standard Portable

Per unit selling price $35.00 100% $24.00 100%

Per unit cost 31.16 89% 19.54 81%

Per unit gross profit $ 3.84 11% $ 4.46 19%

As the gross profit (in both dollars and percentage terms) on the portable model far exceeded that for the standard, company management are planning to emphasise the portable model in subsequent advertising and marketing activities.

However, before finalising the advertising and marketing plan the companys management accountant was asked to prepare a product costing analysis using activity-based costing (ABC). The management accountant accumulated the following information about overhead for the current year.

Activities Cost drivers Estimated Expected use Activity-based

overhead of cost drivers overhead rate

Purchasing Number of $179,000 4,475 $40 per order

orders

Machine Number of $195,000 780 $250 per set-up

set-ups set-ups

Assembly Machine $320,000 80,000 $4 per machine

hours hour

Quality control Tests $160,000 8,000 $20 per test inspection

The cost drivers used for each product were:

Cost drivers Standard Portable Total

Purchase orders 2,500 1,975 4,475

Machine set-ups 480 300 780

Machine hours 60,000 20,000 80,000

Tests and inspect. 5,000 3,000 8,000

Requirements:

(a) Assign the total manufacturing overhead costs to the two products using ABC. (Marks 5)

(b) Determine the cost per unit and gross profit of each model using ABC. (Marks 5)

(c) Evaluate managements plan to focus advertising and marketing activity on the portable model. (Marks 5)