Question 2: Alex has recently started a business in Hong Kong making luxury cakes for the retail trade. Her first product was a sponge cake and she used a simple system to produce products costs in which the overhead cost per unit was based on the budgeted number of units produced. The cost unit used was 1kg of cake. Direct materials for this were $9 and direct labour $10. This line sold well to a number of restaurants and supermarkets, so she decided to add to the range with a luxury fruit cake. This had a different production process it had a longer shelf life and required different protection in the packaging. The direct material here cost $38 and labour was $18 per kg. Alex applied the same costing system to this product. The total budgeted manufacturing overhead was $324,000. Being new into the market Alex wanted to price the products competitively, based on the rough estimates of the costs she had produced. The sponge cake was priced at $60 and the fruit cake at $90. The budgeted sales of both products are shown below: Alex is surprised how well the fruit cake is selling whereas the number of sponge cakes sold is below her expectations. As a result she has asked a local costing expert, Iris, for advice about the costing she had been doing. Iris discovered that within the total budgeted overhead $54,000 applied to the packaging material that was used; sponge cake packaging costs $4 per kg while the fruit cake packaging costs $6 per kg. Iris further analysed the remaining overheads, activities and costs (a system she called activity-based costing - ABC ) involved in making the two products and the results are shown below: Question 2 continued Required: (a) Compute the costs of the two types of cakes based on the simple unit-based system adopted by Alex. Also compute the costs if the total overheads were allocated based on a percentage of the sales value of the cakes. Briefly comment on these methods. (15 marks) (b) Compute the costs of the two types of cakes based on the activities disclosed by Iris. Discuss the differences compared to (a) above, comment on them and explain their implications for the business. (20 marks) (c) Outline the strengths and weaknesses of an ABC system and indicate how any company could use the ABC information to engage in activity-based cost management (ABCM)