Question:

Frantic Plc assembles three types of motorcycle at the same factory: the 50cc Sunshine; the 250cc Roadster and the 1000cc Fireball. It sells the motorcycles throughout the world.

In response to market pressures Frantic Plc has invested heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the size of its workforce.

Historically, the company has allocated all overhead costs using total direct labour hours but is now considering introducing Activity Based Costing (ABC). Frantic Plcs accountant has produced the following analysis.

Annual Output Annual direct labour Selling Price Raw material

(units) hours ( per unit) cost( per unit)

Sunshine 2,000 200,000 4,000 400

Roadster 1,600 220,000 6,000 600

Fireball 400 80,000 8,000 900

The three cost drivers that generate overheads are:

Deliveries to retailers -- the number of deliveries of motorcycles to retail showrooms

Set-ups -- the number of times the assembly line process is re-set to accommodate

a production run of a different type of motorcycle.

Purchase orders -- the number of purchase orders.

The annual cost driver volumes relating to each activity and for each type of motorcycle are as follow:

Number of deliveries Number of set-ups Number of purchase

To retailers orders

Sunshine 100 35 400

Roadster 80 40 300

Fireball 70 25 100

The annual overhead costs relating to these activities are as follows:

Deliveries to retailers 2,400,000

Set-up costs 6,000,000

Purchase orders 3,600,000

All direct labour is paid at 5 per hour. The company holds no stocks.

At the board meeting there was some concern over the introduction of activity-based costing.

The finance director argued: I very much doubt whether selling the Fireball is viable but I am not convinced that activity-based costing would tell us any more than the use of labour hours in assessing the viability of each product.

The managing director argued: I believe that activity-based costing would be an improvement, but it still has its problems. For instance, if we carry out and activity many times surely, we get better at it and costs fall rather than maintain constant. Similarly, some costs are fixed and do not vary either with labour hours or any other cost driver.

The chairman argued: I cannot see the problem. The overall profit for the company is the same no matter which method of allocating overheads we use. It seems to make no difference to me.

Required

1. Calculate the total profit on each of Frantic plc three types of product using each of the following methods to attribute overheads:

1. The existing method based upon labour hours.
2. Activity based costing. (50 marks)

Note: Please show and explain all your workings clearly

[Maximum Word Count 500 words]

2. Write a report to the directors of Frantic Plc, as its management accountant. The report should:

1. Evaluate the labour hours and the activity-based costing methods in the circumstances of Frantic Plc; and (30 marks)

[Maximum Word Count 750 Words]

2. Examine the implications of activity-based costing for Frantic Plc, and in so doing evaluate the issues raised by each of the directors. (20 marks)

[Maximum Word Count 750 Words]