Practice questions for management accounting and decision making

Havana Cooling Ltd is a business that manufactures air-conditioning units for domestic use. There are three models: 3kw, 4kw and 6kw. The 3kw model is a room air-conditioner designed to fit in a window; the 4kw model is also a room air-conditioner but designed to be built-in; the 6kw model is roof-top unit designed to cool a small house or large flat. The models, their quality and their price are aimed at different markets. Product costs are computed on a blanket (business-wide) overhead-rate basis using a labour-hour method. Prices as a general rule are set based on cost plus 20 per cent. The following information is provided: 3kw 4kw 6kw Material cost (/unit) 60 80 140 Direct labour hours (per unit) Budget production/sales (units) 32,600 20,000 60,000 5 The budgeted overheads for the business amount to 8,840,000. Direct labour is costed at 16 an hour. The business is currently facing increasing competition, especially from imported goods. As a result, the 3kw has been put on sale at a 10 discount for each unit - a level that produces a very low profit margin, far below the normal 20% mark-up. To address this problem, an activity-based costing approach has been suggested. The overheads are examined and these are grouped around main business activities of machining (4,720,000), logistics (640,000) and establishment (2,400,000) costs. It is maintained that these costs could be allocated based respectively on cost drivers of machine hours, material orders and space, to reflect the use of resources in each of these areas. After analysis, the following proportionate statistics are available in relation to the total volume of products. 3kw 4kw 6kw Machine hours 15% 20% 65% Material orders 20% 60% Space 18% 24% 58% Continued on next page 20% no/ Required: a) Calculate for each product the full cost and normal selling price determined by: (i) the original costing method (ignoring any discount sale prices) (14 marks) (ii) the activity-based costing method (18 marks) b) What are the implications of the two systems of costing in the situation given? (8 marks) c) What should Havana Cooling Ltd do about pricing in the light of the new information, and what strategic options are there? (10 marks) (Total 50 marks)