Dekemhare Sweet & Cakes Ltd (DSCL) a small family-owned business that manufactures

a wide range of cakes and pastries ordered by retailers, birthday and wedding parties,

local cafs, and coffee shops. At the annual Christmas party, the factory's owner, Mr

Efrem, presented a nostalgic review of the business's history.

He narrated how the factory has commenced its operation and all the progresses it has

made over the years. He noted that the factory had only three product linespies, finger

buns and lamingtons when it started thirty years ago. He said, 'we were busy producing

large volumes of each product, using very simple machinery and a lot of hard work.'

He continued the story saying: it is astounding how things have changed! We still make and

sell a lot of pies and lamingtons, but we also produce a wide range of low-volume lines, such

as Danish pastries, donuts, and vanilla slices. I hear you moaning, and no wonder; these low

volume products are a pain in the neck. They are intricate to produce, and their short

production runs involve a lot of extra machinery setups and material handling. But the

accountants tell me that these speciality lines have superb profit margins, so we must not

grumble. I have no idea of accounting, but I trust what the accountants are doing is great

and have helped us manage the business for many years.

Mr Efrem then delineated the remarkable changes that had occurred within the business

over the past 30 years. These changes relate to the investments made around information

and manufacturing technology. The factory introduced computerized mixing machines

and ovens that replaced majority of the direct labour operations, and an increased

emphasis on quality and delivery performance. Indeed, right across the business, more

and more effort has been made to keep customers happy. Nowadays, it is hard to increase

market share unless customers are satisfied with products. This was not the case at the

time we started business as customers didn't have many options in the market place

compared to the present time.

Things begun to shift a bit when his speech cast a gloomy shadow across the Christmas

festivities. Mr Efrem warned employees saying, despite all the progress, the factory seems

to be struggling. Our profits are declining, and if things don't improve over the next few

months, this may be our last Christmas together. To survive we must all work very hard. We

must focus on increasing sales, particularly of our high-margin specialty products.

Mr Daniel, the factory's management accountant, is worried about the conventional

product costing system currently in use by DSCL. The manufacturing people are also

increasingly exasperated with the costing system. They have recognized that the costing

system is producing faulty information and hence is distorting product costs. However,

they are not sure whether the owner is going to accept their views and take the necessary

steps to fix the wrecked costing system.

Required:

1. Explain how activity-based costing could overcome the deficiencies inherent in the

existing costing system.

2. Mr Daniel is considering to use an Activity-based Costing (ABC) system but not sure

which one to choose from the three options: Simple ABC system, ABC system for

indirect costs and the Comprehensive ABC system. Please explain which of the options

is appropriate to use for the business.