Question

LOVE UCIUL RR di 0 dation on an expansion strategy? EMENT. 05.15 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT, AUTOMOTIVE SUPPLIER O'Sullivan Company is an automotive component supp O'Sullivan has been approached by Honda Canada's Alliston, Ontario, plant to conside expanding its production of part 2422 to a total annual quantity of 2,000 units. This part is a low-volume, complex product with a high cross 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 S1,000 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 Cost Allocation and Activity Based Costing Systems ZUN

Answer 1

1. Here's the schedule calculating unit cost and gross margin using ABC approach:

Cost Driver Annual OH Consumption Cost (Annual) Activity Centre Cost Driver 50 Cost Driver consumption to Per unit produce 2000 cost units C=A/B D 120 100 4 1,400 4 10 50 5 160 500,000 50,000 700,000 300,000 50,000 1,600,000 3,200,000 10000 500 500 60000 1000 10000 Quality Number of pieces Scrapped Production Scheduling Number of Setups Set up Number of Setups Shipping Number of containers shipped Shipping administration Number of Shipments Production Number of machine hrs Indirect OH Cost (Total and per unit cost) Direct Material Direct Labor Total cost and per unit cost Sales price (Quoted) Gross Margin / (Loss) Gross Margin / (Loss) % per Cost for unit 2000 units cost E=C*D E/2000 6,000 3.00 400 0.20 5,600 2.80 50 0.03 250 0.13 2,400 1.20 14,700 7.35 5,000 2.50 1,000 0.50 20,700 10.35 7.50 -2.85 -38.00%

2. Based on ABC analysis, sales price quoted by Honda Canada of $ 7.50 per unit produce loss for O'Sullivan in accepting this proposal. Thus Sale price has to be negotiated to avoid loss and to get profit. From this, it is clear that traditional costing approach might not produce more accurate results for per unit cost and only ABC analysis provide accurate per unit cost. The biggest advantage with ABC analysis is that it measures the significance of each cost item under indirect cost or factory overhead and thus application of each cost towards the total cost will produce more accurate results. But biggest challenge associated with ABC analysis is identifying cost driver for each indirect cost and arriving at the consumption units associated with such cost driver.