Scenario:
You are the newly recruited Financial Advisor of Norman and Co. Ltd. This company absorbs production overhead using machine hours. All products are priced by adding a 25% mark-up on cost to obtain the selling price.
The management has the following information about their products:
Applicable to its products:
Total Overheads = £100,000
Total machine Hours = 50,000 hrs
Product X Y
Units of Production 2,500 5,000
Material Cost p/unit £30 £50
Labour Cost per unit £20 £16
Machine Hrs P/unit 10 5
After interviewing all the important people of the organization you have apportioned the overhead costs as per below:
% Overheads
Set up Costs 35
Inspections 45
Materials Handling 20
Cost Pools are as follows:
X Y Total
Set ups 300 50 350
Inspections 500 250 750
Goods Movements 300 700 1000
The financial director of Norman and Co Ltd. is considering replacing the existing traditional system with activity based costing but is unsure exactly what would be involved. He is also determined to keep costs to a minimum and does not want any new system to involve a lot of extra work or expenditure.
Required:
Prepare a report for the financial director which must address the following:
1. An appraisal of the existing traditional system. (What is the Cost per unit of X and Y under Traditional Absorption Costing)
2. A broad outline of an ABC system with an explanation as to why it might be desirable.
3. Your recommendations for ABC implementation and any problems you foresee bringing in ABC for Norman and Co. Ltd. What is the Cost per unit of X and Y under ABC
4. Your advice on whether ABC is viable for Norman and Co. Ltd., given the financial directors concerns.