Question

LIVE UCIUI ing di 10 OD dation on an expansion strategy? CEMENT 05-15 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT, AUTOMOTIVE SUPPLIER O'Sullivan Company is an automotive component supplie motive component supplier. O'Sullivan has been approached by Honda Canada's Alliston, Ontario, plant to consider 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 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 33,3% Cost Allocation and Activity Based Costing Systems AU

Answer 1

1-	Factory overhead	value of factory overhead	cost driver	quanity of cost driver	value of cost driver per unit of cost driver = value of overhead/quantity of total overhead cost driver	Units of cost driver assigned to product	overhead assigned to product = value of cost driver per unit of cost driver*units of cost driver assigned to product
	Quality	500000	no. of pieces scrapped	10000	50	120	6000
	prduction schedule	50000	number of set ups	500	100	4	400
	set up	700000	number of set ups	500	1400	4	5600
	shipping	300000	no. of container shipped	60000	5	10	50
	shipping administration	50000	number of shipments	1000	50	5	250
	production	1600000	number of machine hours	10000	160	15	2400
	total Indirect production cost	3200000
	total cost of production for 2000 units						14700
	No of units produced						2000
	total cost of production per unit						7.35
	cost of production per unit
	Direct material			2.5
	Direct labor			0.5
	Indirect cost of production			7.35
	total cost of production per unit as per Activity based costing			10.35
	Selling price per unit		7.5
	total cost of production per unit as per Activity based costing		10.35
	gross profit/loss per unit		-2.85
2-	I would recommend the implementation of activity based costing because the currently employed costing system is not allocating the indirect cost in the proportion in which cost has been incurred. Prodcut is selling at a price lower than the cost and it is incurring losses. correct way to assign the indirect cost is ABC costing as it assigns the cost on the basis of cost driver which more appropriately assign the indirect cost on the basis of units of cost drivers. one of disadvantage of ABC costing is that it is difficult to find out the cost driver to the concerned activity.