Question 3

Traditional Overhead Allocation and Activity-Based Costing Methods (Total: 30 marks)

Wine Plus Ltd is famous for its wine products. Ordinary Wine is standard Wine, while Miracle Wine is produced using a secret recipe. Only Wine Plus Ltd can produce the Miracle Wine.

All costing information is based on the following expected output for 2020.

Ordinary Wine

Miracle Wine

Sales Price (per bottle)

$100

$130

Expected demand and output for 2020

180,000 bottles

60,000 bottles

Budgeted Costs for 2020

Direct Costs

Ordinary Wine

Miracle Wine

Total

Direct Material Costs

$398,250

$288,900

$687,150

Direct Labour Costs

$211,512

$126,000

$337,512

Total Direct Costs

$609,762

$414,900

$1,024,662

Sophie, the accountant for Wine Plus Ltd has been using the traditional approach to overhead allocation. Production overheads are allocated to products using labour as the allocation base. Variable production overheads are 15% of labour cost. Fixed production overheads are 110% of labour cost at the budgeted 2020 level of production. Selling and Administration is 10% of the selling price, with half being fixed and half being variable.

Recently, Sophie has had some concerns about the accuracy of the costing information produced. The production system is significantly automated, but the traditional overhead allocation is based on labour costs. She has investigated the activity-based costing (ABC) approach and has come up with the following budgeted figures for the cost drivers and their related activities.

ABC Approach

Activity

2020 Budgeted Cost

Driver

Machine set-ups

$757,500

Machine set-ups

Machine running

$951,750

Machine hours

Materials handling

$340,804

Number of materials requisitions

Inspections

$268,944

Number of inspections

Sales order processing

$227,026

Number of orders processed

Total Cost

$2,546,024

Expected use of activity drivers for the level of production predicted for 2020:

Driver

Ordinary Wine

Miracle Wine

Total

Machine set-ups

1200

1800

3000

Machine hours

12000

18000

30000

Number of materials requisitions

240

660

900

Number of inspections

180

420

600

Number of orders processed

900

600

1500

Question 3 Continued

Required:

(a)Use the traditional overhead allocation method to calculate for each Wine product:

(i)The total cost (round to nearest $)

(ii)The profit percentage (round to nearest %)

(10 marks)

Ordinary Wine

Miracle Wine

(b)Use the ABC approach to calculate for each Wine product:

(i)The total cost (round to nearest $)

(ii)The profit percentage (round to nearest %)

(12 marks)

Ordinary Wine

Miracle Wine

Question 3 Continued

(c)Based on your findings from parts (a) and (b) above (total costs and profit), what recommendations should Sophie make to Wine Plus Ltd?(3 marks)

(d)A special order for Miracle Wine has been received by Wine Plus Ltd. The customer wants to place an order of 15,000 bottles for a special price of $120 per bottle. The factory is working at 80% capacity at its current budgeted level. The variable cost per unit has been estimated to be $36 per bottle. There will be no other fixed costs incurred for this special order.

(i)Should Sophie advise Wine Plus Ltd to accept the special order from the customer? Give your reasons and supporting calculations. (3 marks)

(ii)The customer was pleased with the quality and popularity of the Miracle Wine and now wants to increase the order to 75,000 units on an annual basis at the same special price of $120 per bottle. Should Wine Plus Ltd continue to supply this customer on an annual basis at this price? Provide clear explanations to justify your answer. (2 marks)