Question

JCX Ltd operates in a highly competitive market and is involved in the production of parts for the farming industry. It has plants in Auckland, Wellington, Christchurch and Dunedin. One of its plants, the Wellington Plant, specialises in the production of two parts: JCX-1 and JCX-2. Part JCX-1 produced the highest volume of activity, and for many years, it was the only part produced by the plant. Five years ago, Part JCX-2 was added. Profits increased for the first few years after the addition of the new product. However, in the last two years the plant has faced intense competition and its sales of Part JCX-2 has dropped. In fact, the plant showed a small gross loss in the most recent reporting period. Much of the competition was from foreign sources, and the plant manager was convinced that the foreign producers were guilty of selling parts below their cost of production. The plant currently uses a traditional costing system where only manufacturing overhead costs are allocated to products using a predetermined plant-wide overhead rate based on direct labour hours. The company’s CEO Jim James has recently attended a leadership conference in London and was very impressed by a presentation given by Nicola Toms, CFO of a large manufacturing company, on ABC. Jim managed to arrange a private meeting with Nicola to explore her experiences with the development and implementation of ABC in her organisation. After the meeting, Jim was convinced that JCX could benefit from the implementation of ABC. He agreed with Nicola’s view that as the level of external environment factors increases, more reliable product cost information is needed. He was very impressed with how Nicola went about her implementation strategy. In particular, he noted Nicola’s emphasis on the importance of clearly addressing up-front major issues that are likely to arise when seeking buy-in of the managers in the organisation. Jim took notes of those issues as follows.

ABC is too complex and expensive to implement. ABC can be prone to misuse by constant revision of the cost pools or cost drivers.

In ABC, not all overhead costs, such as CEO salary, can be allocated to specific activities.

If ABC is implemented, other systems, such as variance analysis, may have to be changed resulting in disruptions and costs. While many organisations have experimented with ABC as a one-off exercise, not many adopted ABC as an ongoing costing system.

1. Present five external business environmental factors affecting JCX costs and explain the implications of those factors to the quality of product cost information under the current costing system.?