CASE 2: (Activity-Based Costing)

Harvey Ltd. Produces three products: Fridges, Dishwashers and Washing machines. The company uses a single plant-wide factory overhead rate to all three products based on direct labour hours. The company currently uses plant-wide factory overhead allocation based on direct labour hours. The company also adds a 20% mark-up on the cost of production to cover administration cost and gross margin. The selling price per unit for the three products are as follows:

Fridge - $1043.85

Dishwasher$911.76

Washing machines 784.36

However, the company has noticed that of the three products the Fridges and Dishwashers are high in demand at the set price and are selling fast, but the Washing machines are not selling even if the quality is quite good. The management is asking you to find out the possible reasons for this. They suspect that there may be something wrong with their costing and pricing. They have heard that Activity Based Costing (ABC) is capable of producing more accurate costing and pricing. They supply you with the following information:

FridgeDishwasher Washing machines

Material cost (per unit)$700.00$300.00$500.00

Labour cost (per units)2.5 hours 5 hours3.0 hours

@ 40.00/hour@ $40.00/hour @ $50.00/hour

The total budgeted annual production overhead cost of the company is $1 400 000.The company has supplied you detailed information and breakdown about their overhead cost.

The company has determined the major activities and cost pools that account for the total overhead cost of the company. These activities, along with their budgeted activity costs, are as follows:

ActivitiesBudgeted Activity Cost

1.Machine Set Up$ 428 750

2.Production Control$ 245 000

3.Inspection and Quality Control$ 183 750

4.Materials Handling$ 367 500

5.Indirect Labour$ 175 000

Total:$ 1 400 000

Sorrento Ltd has estimated the following activity-base usage and units produced for each of its three products:

ProductsNo. of No. of No. ofNo of No. of Direct

unitsSetupsProduction Inspections materials Labour Hours

ordersmoves

Fridge10 00080803532025 000

Dishwasher 2 00040404040010 000

Washing machine 50 00055030140 000

Total 62 000 12512575750175 000

Required:

1.Using the single plant-wide factory overhead rate method determine the applied factory overhead cost per unit for the Fridge, Dishwasher and Washing machines.

2.Calculate the total unit cost of production for each product using the material and labour cost information provided to you and the overhead cost you have calculated in 1 (above).

3.Determine the factory overhead cost and total cost of production per unit for the Fridge, Dishwasher and Washing machines using the Activity Based Costing.

4.Which method provides more accurate product costing? Why?

5.Explain to the management of Harvey Ltd. why the Fridge and Dishwashers were selling fast and the Washing machines were not selling at the existing prices.