CowFarm produces two "Gourmet Supper" prepared meals. The company currently allocates overheads to units using a traditional method based on machine hours. The management accountant has concerns over the accuracy of the information and is considering introducing Activity Based Costing to allocate overheads to units.

The following information relates to the budget for the year ahead:

Activities Budgeted Production Overhead

Food Processing 90,000

Batch Preparation 60,000

Total 150,000

Direct materials Product data GS1 GS2

Production / Sales (units)75,000 15,000

Direct materials cost per unit () 1.90 2.90

Direct labour hours per unit (hours)0.1 0.2

Machine hours per unit in machining process (hours) 3 5

Number of machine Set Ups per batch of 500 meals 2 5

It is estimated that direct labour costs will be 10 per hour for the budgeted period and a profit mark up of 35% of total product cost is added to attain the selling price.

Using the current traditional costing method the total budgeted product cost for GS1 is 4.40 and for GS2 is 7.40.

Both products are produced in batches of 500 units per batch.

The sales manager has reported that sales for GS2 have fallen, however, the sales for GS1 have risen. The sales manager has suggested that the sales price for GS2 be reduced.

The total direct materials cost, total direct labour cost and the total direct cost to produce 75,000 GS1 and 15,000 GS2 are shown below :

Direct costs GS1 GS2

Output in units 75,000 15,000

Direct materials cost per unit () 1.90 2.90

Total Direct Material cost () 142,500 43,500

Direct labour hours per unit (hours) @ 10 per hour 0.1 0.2

Direct Labour Cost per unit () 1.00 2.00

Total Direct Labour cost () 75,000 30,000

Total Direct Cost () 217,500 73,500

The total number of machine hours in the food processing, the total number of batches required and the total number of machine setups in the batch preparation process to produce 75,000 GS1 and 15,000 GS2 are shown below:

GS1 GS2Total

Output in units 75,000 15,000

Machine hours per unit in food processing (hours) 3 5

Total number of machine hours 225,000 75,000300,000

Number of set ups per batch 25

Total number of batches (Output/batch size) 50 30 180

Total number of machine setups 300 150 450

Required:

(a) Using ABC revise the total budgeted production overhead cost for each of the meals by allocating the production budgeted overhead costs for the activities Food Processing and Batch Preparation based on the cost drivers machine hours and machine setups.

Allocation of overheads using ABC GS1 GS2 Total

Output in units 75,000 15,000

Total number of machine hours 225,000 75,000 300,000

Allocate Machining budgeted production cost 90,000

Total number of machine setups 300 150 450

Batch Preparation budgeted production cost 60,000

Total Budgeted Production Overhead Cost 150,000

(b) Calculate the revised total and per unit budgeted product costs using ABC.

GS1 GS2 Total

Output in units 75,000 15,000

Total Budgeted Production Overhead Cost 150,000

Total Direct Costs 217,500 73,500 291,000

Total Budgeted Product Cost 441,000

Per unit Budgeted Product Cost using ABC

c) Calculate the revised selling price for each meal using the ABC budgeted total cost and compare the results to those given by using the current traditional costing and sales price information given in the question.

GS1 GS2

Budgeted Product Cost per unit using ABC

Revised Selling Price using ABC @ 35% profit mark-up

Budgeted product cost using current traditional method () 4.40 7.40

Current sales price after profit mark up 35% () 5.94 9.99

(d) State, giving reasons, whether or not, the sales price for the GS2 meal should be reduced to increase sales.

(e) Briefly, critically evaluate Activity Based Costing