Case study

The companys current costing system has two direct cost categories (materials and labour) and one manufacturing overhead costs. The simple costing system allocates manufacturing overhead costs based on the machine-hours. The rate for the period is RM25 per machine hour. The following data was extracted in relation to the production using current cost system.

Mr. Tarmizi believes that the current costing system may be providing misleading cost information to the company after reading some journal articles on Activity-Based Costing (ABC). He immediately formed an ABC taskforce to help him with the compilation of data. After analyzing the manufacturing activities and costs for Southern Digital, the taskforce identified five activities as generating manufacturing costs: production scheduling, material handling, machine setup, assembly, and inspection.

Further analysis shows that the total of manufacturing overhead costs for each activity can be divided as follows:

The study by the taskforce revealed the following information pertaining to cost drivers and marketing cost:

The people in the production-scheduling department, process, inspect and move each batch of components for a production run. This work required the same amount of time regardless of whether the production run was long or short. Thus, the appropriate cost driver should be production runs.

The machine setup overhead was generated by charging the job to be run and should be related to the setup hours rather than the direct labour-hours.

The assembly overhead related to costs incurred for cutting, trimming, and sanding operations. Therefore, the correct cost driver was found to relate more to the machine hours of a product.

The inspection overhead arose from inspecting the finished goods. The higher the number of finished units, the higher the inspection overhead costs. The appropriate cost driver should be the number of inspections.

The overhead costs for material handling had nothing to do with direct labour-hours.

These costs were more likely to vary with the number of material movement.

The taskforce gathered the following information about the cost driver volume for each product:

You are working in Southern Digital Sdn. Bhd. during your internship as a member of its taskforce. You are required to prepare a business report on behalf of the taskforce. The intention of the business report is to provide Mr. Tarmizi with a better understanding of the situation in the company. The business report would need to cover the information listed in the next page.

Required

Part A: Calculation (show detailed workings) (36 Marks)

1. Using current costing system,

a. Calculate the total manufacturing overhead costs for the company using

machine-hour as the single allocation base. (1 marks)

b. Calculate the total direct labour costs for the year. (2.5 marks)

c. Compute the manufacturing overhead cost for each product. (2 marks)

d. Compute product cost and product cost per unit of each product. (5 marks) e. Compute the profit and profit margin for each product. (4 marks)

2. Using activity-based costing system,

a. Calculate manufacturing overhead cost for each activity. (2.5 marks)

b. Compute the manufacturing overhead cost allocation rate for each activity. (5 Marks)

c. Compute the manufacturing overhead cost allocated to each product. (5 marks) d. Compute product cost and product cost per unit for each product. (5 marks)

e. Compute the profit and profit margin for each product. (4 marks)

Southern Digital Sdn. Bhd. produces and supplies a variety of ICT circuit boards. Gold circuit board and Platinum circuit board are two boards that account for most of the companys sales. Southern Digital normally produces 3,200 units of Gold circuit board and 1,800 units of Platinum circuit board. Tech World Sdn. Bhd. (TWSB) is one of the main customers in Southern Digitals list. They signed the original contract back in March 2018, and are expected to ink the renewal contract in April 2020. Recently, Tech Worlds purchasing manager informed Chief Executive Officer (CEO) of Southern Digital, Mr. Andrew that Gadget Houses (Southern Digitals leading competitor) is offering to supply Gold circuit board at a price of RM95, well below the RM105 that Southern Digital offered.

Mr. Andrew immediately held a meeting with his top management team. The atmosphere in the meeting was filled with apprehension, as Mr. Andrew discussed the latest operating results with the managers of the Company. Mr. Andrew mentioned in the meeting:

Gold circuit board is the major product line of our company. The severe price cutting in Gold circuit board prices will surely reduce our gross profit for Gold circuit. The decline in profit is not sustainable. Fortunately, our competitors are overlooking the opportunities for profit in Platinum circuit board. In fact, the same competitive pressures do not exist for the Platinum circuit board, which Southern Digital currently sells to Tech World Sdn. Bhd. at RM175. We are left with several alternatives. First, we may just give up the contract for Gold circuit boards if selling them will reduce our profit. Second, we must find ways to reduce the price of the Gold circuit. Finally, we must accept a lower margin or aggressively seek to reduce costs. After all we must find ways to maintain our Gold circuit board contract and maintain our company policy to achieve 10% profit margin for both products.

Mr. Andrew, CEO, Southern Digital

The accountant, Mr. Tarmizi believes that before the management group proceeds with the discussion about giving up selling Gold circuit board to Tech World, it might be worthwhile to look at the companys costing system. Tarmizi explained to the management group,

Activity-based costing (ABC) integrates the cost of all activities, known as cost drivers, into individual product costs rather than including these costs in the overhead pool. We can calculate an activity-based cost for each Gold circuit board and each Platinum circuit board and then compare it to the current costing system we have been using.

Mr. Tarmizi, Accountant, Southern Digital

Direct material cost per unit Direct labour cost per hour Direct labour hour per unit Gold RM30 RM16 1.5 Platinum RM45 RM16 2.25 Activity cost pool Production scheduling Material handling Machine setup Assembly Inspection Total manufacturing overhead Overhead cost 40% 20% 10% 25% 5% 100% Activity cost driver Production runs Material moves Machine setups Machine-hours Number of inspections Gold 40 75 45 5,500 250 Platinum 85 175 155 4,500 150 Direct material cost per unit Direct labour cost per hour Direct labour hour per unit Gold RM30 RM16 1.5 Platinum RM45 RM16 2.25 Activity cost pool Production scheduling Material handling Machine setup Assembly Inspection Total manufacturing overhead Overhead cost 40% 20% 10% 25% 5% 100% Activity cost driver Production runs Material moves Machine setups Machine-hours Number of inspections Gold 40 75 45 5,500 250 Platinum 85 175 155 4,500 150