You have recently been hired on a contract basis by Xeres Limited, a company which manufactures a range of sophisticated products, the biggest seller of which is the 'Opta' (annual sales of this item amount to 8,000 units per annum). The first assignment you have been given has the following detail: 

A long-standing customer has offered to purchase a large volume of 'Opta'. However, the customer is seeking a 30% discount off the normal selling price. 

The cost card (direct costs only) for the product is as follows: 

Notes                                                                                          € 

Material                                              0.5 kilos                     45 

Labour                                                1 labour hour              15 

Finishing costs                                   1 machine hour          8 

Direct costs                                                                            68 

Note: The current basis of charging fixed overheads to units of production is explained later in the QUESTION. To compute a product's selling price, the company adds fixed overheads to direct costs to compute manufacturing cost and then adds a mark-up of 30% to the manufacturing cost. 

•         The Chief Financial Officer (CFO) is opposed to accepting the deal under the proposed terms. He notes that since the selling price of this product is calculated using a mark-up of 30% of cost, the company cannot agree to the pricing terms requested by the customer. He has publicly dismissed the deal to be "a nonrunner". 

•         The Chief Manufacturing Officer (CMO) however, disagrees with the Chief Financial Officer and feels that there may be scope for accepting the deal. He feels that since the customer has been (and continues to be) a "key-account" customer for many years that an extra effort ought to be made to meet the demand. He fears that a refusal might be seriously detrimental to the ongoing relationship between the customer and Xeres Limited. 

•         Your task is to resolve the disagreement between the CFO and the CMO and report your proposed resolution to each of these officers. 

In your efforts to resolve the dispute, you have undertaken some preliminary research and have collected the following information: 

1.                 The company currently uses an absorption costing system to charge overheads to products. These overheads total €700,000 per year. The current basis of charging fixed overheads to units of production is summarised in the following table: 

                                        Overheads charged              Overheads charged 

                                 using labour hours               using machine hours 

€                                             € 

Total annual overhead                      400,000                                  300,000 

Total annual hours                             20,000                                    25,000 

2.                 A study undertaken by external consultants identified the following drivers of the annual fixed overheads incurred by the company: 

Total number of cost                            Total amount of                                                                                                                                                                            overhead cost driver

                                                                                                                 events per annum €

Purchasing/goods inward costs          1,200                                                30,000 

Machine set-up/ retooling                    6                                                       90,000 

Quality control inspections                 8,000                                                 500,000 

Despatch/ goods outward costs          5,000                                              80,000 

Total annual overhead cost                                                                            700,000

You analysed the activities referable to the 'Opta' product for the past year and have determined the following information: 

Cost driver                                        Number of cost driver 

                                                           events per annum 

Purchasing / goods inward costs        120 

Machine set-up/ retooling                      2 

Quality control                                      2,000 

Despatch/ goods outward costs         500

REQUIREMENT: 

(a)              Calculate the current fixed overhead absorption rates used by the company. 

(b)             Calculate the current selling price of the 'Opta' product. 

 

(c)              Calculate the total overheads which would be charged to the annual production of 'Opta's' using activity based costing principles and the amount per unit.