Question

25-15 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT, AUTOMOTIVE SUPPLIER O'Sullivan Company is an automotive component supplier. O'Sullivan has been approached by Honda Canada's Alliston, Ontario, plant to consider expanding its production of part 24Ž2 to a total annual quantity of 2,000 units. This part is a low-volume, complex product with a high gross margin that is based on a proposed (quoted) unit sales price of $7.50. O'Sullivan uses a traditional costing system that allocates indirect manufacturing costs based on direct labour costs. The rate currently used to allocate indirect manufacturing costs is 400 percent of direct labour cost. This rate is based on the $3,200,000 annual factory overhead cost divided by $800,000 annual direct labour cost. To produce 2,000 units of 24Z2 requires $5,000 of direct materials and $1,000 of direct labour. The unit cost and gross margin percentage for part 24Z2 based on the traditional cost system are computed as follows: Per Unit (+2,000) Total Direct materials Direct labour Indirect production: (400% direct labour) Total cost Sales price quoted Gross margin Gross margin percentage $ 5,000 1,000 4,000 $10,000 $2.50 0.50 2.00 $5.00 7.50 $2.50 33.3% Cost A

Answer 1

Refer the below images for the above mentioned questions, in a detailed way of solution.

Solution : Requirement 0 : Cast | Activity centre cost - Allocation Base cost Total Annual cos Annual cost Driver Activity COST per Driver chit Cost Driver Consumption part 2422 part 2422 $10 120 10 000 Soo & Gooo 400 100 5600 500000 5oodo 7ooooo 300000 Joboo 1600000 soo 6oooo 1000 sao So 250 10000 2ҷоо $ 3200000 $14700 Quality: pieces scrapped production Schedding: setups Setup & serups Shipping containers shipped Shipping admin: Shipments production: Machine-hours Total indirect cost Direct materials Direct labor Total cost of part 2422 (ost per unit ($20700 2000) selling price Gross margin Gross margin percentage 5000 1000 $20700 $10.35 7:50 4(2-81) (38.)

Requirement : Assuming the results of the activity analysts are accurate, product 2422 is much more costly than o' Sullivan's existing costing System estimates. The existing System is ondercosting product 2422 by 11035-$5.00 af 5.35 per unit, tor) $5.35 10.35 = 52% Honda's proposal should be defected unless it is willing to increase the price cor) o Sollinian can significantly reduce its corts. O'sullivan Should be aware, however, that the existing costing system is also overcosting some products Since all indirect costs are allocated. the The activity activity based bared costing costing system should be used to cost all - product product lines lines "winners" in in order bosollivan's to identity order as well as its "losers". Benefits of activity - based implementation include: - More accorate costing of activities, products, costomers other colt objects. - A solid foundation for activity based management using ABC information ase management tool for budgeting planning, and control purposes. An effective Commonication tool, since successful ABC implementation should involve all functional areas of the company. costs of implementing actevity-based costing include: - The cost of a pilot study includes salaries of managers who are dedicated to the study, Consultants are often necessary, Data collection is extensive since operational and financial data are often not available as required to support the new ABC system - It may be necessary to maintain an ABC System Separate from the actounting system used for external reporting.