Question 4 Sanctuary Ltd manufacturers high-quality pens. For many years the company manufactured only one type of pen (ballpoint pens), but last year the company decided to manufacture fountain pens. The decision to begin manufacturing fountain pens was taken after the company's marketing manager confirmed that there was a significant niche market for fountain pens. Further, the company's cost accountant estimated that the cost of production for such pens would be much less than the selling price predicted by the marketing manager. When the fountain pen was introduced, sales in terms of both quantity and price) were higher than expected. Nevertheless, the overall profits of Sanctuary Ltd. have declined steadily. As a result, the cost accountant decided that she should re-examine her estimate of the cost of producing the fountain pen, with particular reference to overhead costs. In her original analysis, she allocated all manufacturing overhead costs to products in proportion to direct labour cost. However, in her re-examination she decided that activity-based costing should be used to gain a more thorough understanding of the situation. The following data is available for the most recent month: Direct cost of production, per unit of each product: Direct materials cost Direct labour cost Ballpoint pen 11.25 2.50 Fountain pen 18.75 5.00 Number of units of each product produced and sold: Ballpoint pen 32,000 Fountain pen 4,000 Units produced and sold Manufacturing overhead costs for the month: Activity cost pool Machine running costs Stores requisitions Materials movements Production set-ups Activity measure Machine hours Number of requisitions Number of movements Number of batches Cost 91,000 189,500 67,500 102.000 Total = 450,000 Activity levels in relation to each product: Ballpoint pen 7.500 500 Fountain pen 10.000 500 Total 17.500 1,000 Activity Machine hours Number of requisitions Number of movements Number of batches 125 450 50 25 75 Cont. next page Requirement (a) Calculate the cost per unit for each of the two types of pen, if all manufacturing overheads are allocated to products in proportion to direct labour cost. 4 Marks (b) Calculate the cost per unit of each of the two types of pen, if all manufacturing overheads are allocated to products using activity-based costing. 10 Marks (C) Explain why the calculated cost per unit of the fountain pen is much higher in part (b) than in part (a), and suggest other factors that may have contributed to the decline in the company's profitability since the fountain pen was introduced. 6 Marks (d) Briefly outline the potential benefits to an organisation of using an activity-based costing system. 5 Marks Total 25 Marks