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.

(d)Calculate the revised manufacturing cost of an 'Opta' using activity based costing principles.