Jazzy Books DAC produces a range of notebooks and diaries that are sold exclusively online via the companys website. Customers can personalise their purchase by selecting designs for the front and back covers of the notebooks or diaries. The company currently uses a traditional overhead absorption costing system based on machine hours to allocate manufacturing overheads to products. This year, the company recorded a loss in its financial statements for the first time since it commenced trading six years ago. The managing director is very concerned and has suggested that the prices of all products should be increased by 25%. However, the management accountant has suggested that the problem relates to overhead allocation. He has argued for the adoption of activity-based costing.

Activity based cost information obtained for the company shows that customers place individual orders and then discuss the design of the notebooks or diaries using emails. The artwork costs depend on the number of setups required to compile the notebook or diary. In addition, the company has a policy of despatching each order individually. Financial information relating to the most recent trading period and two orders recently received are provided below:

Overhead costs

Ordering costs 7,200

Design expenses 28,500

Artwork 17,250

The despatch costs 10,800

Activity drivers

Total orders received 48,000

Total design consultation emails 356,250

Total artwork setups 115,000

Total packets despatched 90,000

Total machine hours 21,250

Details of two orders received

Order reference Notebook KJ34 Diary XT501

Direct materials paper, binding, etc. 1.86 1.24

Direct labour 0.52 0.68

Machine hours required 0.20 0.30

Number of design consultations 3 5

Number of artwork setups required 4 8

(a) Calculate the cost of each of the orders received using:

(i) The existing overhead allocation method

(ii) Activity based costing (ABC) )

(b) Comment briefly on your answers at (a) (i) and (ii) above.

(c) Outline TWO disadvantages of ABC.