Background information GAM Ltd. is one of the automotive industry's most iconic brands. The company's name is synonymous with years of world-first innovation, responsible for ground-breaking turbocharging technologies that have redefined performance and mobility. From mainstream passenger vehicles to F1 racing cars, GAM Ltd.'s turbo technology has been the boost behind some of the most significant moments in automotive history. Mr. Craig Balis, the new CEO of the company wants to improve the profitability and liquidity of the company. Thus, under the new leadership, GAM Ltd will continue to set the pace, to create the differentiated high-performance systems that deliver competitive advantage to its customers and help redefine the end user experience through experience, talent and a mindset that challenges convention. GAM Ltd assembles three types of turbo engines at the manufacturing facility in Ireland: the XTF505; the XTF605 and the XTF905. GAM Ltd sells its turbo technology throughout the world. In response to market pressures, the Board of GAM Ltd has decided to invest heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the size of its workforce. At the moment, GAM Ltd allocates all overhead costs using total direct labour hours but is now considering introducing activity-based costing (ABC) Jessica Zhang, the accountant of GAM Ltd has provided the following information for your perusal. Page 3 of 6 All direct labour is paid at 5 per hour. The company holds no stocks. At a board meeting there was some concern over the introduction of activity-based costing. The finance director, Mr Olivier Rabiller argued: 'I very much doubt whether selling the XTF905 is viable, but I am not convinced that activity-based costing would tell us any more than the use of labour hours in assessing the viability of each product.' The marketing director, Mr Josh Kapp argued: 'I am in the process of negotiating a major new contract with a turbo engine rental company for the XTF505 model. For such a big order they will not pay our normal prices, but we need to at least cover our incremental costs. I am not convinced that activity-based costing would achieve this as it merely averages costs for our entire production.' The managing director, Mr. Craig Balis argued: I believe that activity-based costing would be an improvement, but it still has its problems. For instance, if we carry out an activity many times surely, we get better at it, and costs fall rather than remain constant. Similarly, some costs are fixed and do not vary either with labour hours or any other cost driver.' The chairman, Mrs Rosalie Potter argued: I cannot see the problem. The overall profit for the company is the same no matter which method of allocating overheads we use. It seems to make no difference to me.' Required 1. Calculate the total profit on each of the three types of turbo engines using: a. Absorption costing b. Activity-based costing. 2. Discuss the points raised by the board members 3. Using some appropriate academic peer reviewed literature, compare and contrast the two costing methods The three cost drivers that generate overheads are: Deliveries to retailers: the number of deliveries of turbo engines to retail showrooms Set-ups: the number of times the assembly line process is re-set to accommodate a production run of a different type of turbo engine Purchase orders: the number of purchase orders The annual cost driver volumes relating to each activity and for each type of turbo engine are as follows: The annual overhead costs relating to these activities are as follows: Page 4 of 6
