Assignment Description

Madina Electrical Corporation manufactures electric motors for commercial use. The company produces three models called SM, DM and HDM. The company uses a job costing system with manufacturing overhead applied on the basis of direct labour hours. The system has been in place with little change for 30 years. Product costs and annual sales data are as follows:

	SM	DM	HDM
Annual sales (units)	42500	1700	20000
Product costs:
Raw material	$27.50	$47.75	$73.00
Direct labour	$20.00	$35.00	$35.00
Manufacturing overhead	$240.00	$350.00	$350.00

For the past 13 years, the companys pricing formula has been to set each products budgeted price at 110 per cent of its full product cost. Recently, however, the SM motor has come under increasing price pressure from offshore competitors. As a result, the price on the SM has been lowered to $210.

The company CEO recently asked the financial controller, Why cant we compete with these other companies? Theyre selling motors just like our SM for $290. Thats only $2.50 more than our production cost. Are we really that inefficient?

The financial controller responded by saying, I think this is due to an outmoded product costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my opinion, our product costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean.

Getting the CEOs go-ahead, the financial controller compiled the basic data needed to implement an Activity-Based Costing system. These data are displayed in the following tables. The percentages are the proportion of each activity driver consumed by each product line.

	Product lines
Activity	Activity driver	SM	DM	HDM
Depreciation, machinery	Machine time	40%	13%	47%
Maintenance, machinery	Machine time	40%	13%	47%
Engineering	Engineering hours	47%	6%	47%
Inspection and repair of defects	Engineering hours	47%	6%	47%
Purchasing, receiving and shipping Material handling	Number of material orders	47%	8%	45%
Depreciation, taxes and insurance for factory Miscellaneous manufacturing overhead	Factory space usage	42%	15%	43%

Activity Costs

Activity	Estimated costs ($)
Depreciation, machinery	2675000
Maintenance, machinery	175000
Engineering	650000
Inspection and repair of defects	475200
Purchasing, receiving and shipping	389600
Material handling	500000
Depreciation, taxes and insurance for factory	600000
Miscellaneous manufacturing overhead	742500

Required

Read the above scenario and write a report to the managing director discussing the following key areas:

1. How Madina Electricals traditional product costing system distorts the product costs of the SM, DM and HDMs and prices. Note: You are required to calculate per unit cost and target price.
2. Discuss general problems associated with Madina Electrical Corporation traditional costing system and highlight any indicators that the current costing system is outdated and flawed.
3. Calculate per unit cost and target price for each product line using Activity-Based Costing (ABC) system. (Note: calculate the rate per activity driver to be used in the desired activity-based costing system. Round up to the nearest two decimal points)
4. Discuss costs and benefits of adopting Activity Based Costing for Madina Electrical Corporation.
5. Analyse and explain the differences in the product costs and target prices for each product line between the two alternative costing systems. Discuss likely reasons for the identified differences.