QUESTION 5
Abkaber plc assembles three types of motorcycle at the same factory:
The 50cc Sunshine;
The 250cc Roadster and
The 1000cc Fireball.
It sells the motorcycles throughout the world. In response to market pressures Abkaber plc has invested
heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the
size of its workforce. Historically, the company has allocated all overhead costs using total direct labour
hours, but is now considering introducing activity-based costing (ABC). Abkaber plc’s accountant has
produced the following analysis.
Annual Output (units) Annual Direct Labour Hours Selling Price ($ per unit) Raw material cost ($ per unit)
Sunshine 2000 200 000 4000 400
Roadster 1600 220 000 6000 600
Fireball 400 80 000 8000 900
The three cost drivers that generate overheads are:
Deliveries to retailers – the number of deliveries of motorcycles to retail showrooms
Set-ups – the number of times the assembly line process is re-set to accommodate a production run of a
different type of motorcycle
Purchase orders – the number of purchase orders.
The annual cost driver volumes relating to each activity and for each type of motorcycle are as follows:
Number of deliveries to retailers Number of set-ups Number of purchase orders
Sunshine 100 35 400
Roadster 80 40 300
Fireball 70 25 100
The annual overhead costs relating to these activities are as follows:
$
Deliveries to retailers 2 400 000
Set-up costs 6 000 000
Purchase orders 3 600 000
All direct labour is paid at $5 per hour. The company holds no stocks. At a board meeting there was
some concern over the introduction of activity-based costing.
The finance director argued: ‘I very much doubt whether selling the Fireball is viable but I am not
convinced that activity-based costing would tell us any more than the use of labour hours in assessing
the viability of each product.’
The marketing director argued: ‘I am in the process of negotiating a major new contract with a
motorcycle rental company for the Sunshine model. For such a big order they will not pay our normal
prices but we need to at least cover our incremental costs. I am not convinced that activity-based
costing would achieve this as it merely averages costs for our entire production.’
The managing director argued: ‘I believe that activity-based costing would be an improvement but it still
has its problems. For instance, if we carry out an activity many times surely we get better at it, and costs
fall rather than remain constant. Similarly, some costs are fixed and do not vary either with labour hours
or any other cost driver.’
The chairman argued: ‘I cannot see the problem. The overall profit for the company is the same no
matter which method of allocating overheads we use. It seems to make no difference to me.’
Required:
(a) Calculate the total profit on each of Abkaber plc’s three types of product using each of the following
methods to attribute overheads:
(i) the existing method based upon labour hours; and
(ii) activity-based costing. (13 marks)
(b) Write a report to the directors of Abkaber plc, as its management accountant. The report should:
(i) evaluate the labour hours and the activity-based costing methods in the circumstances of Abkaber
plc; and
(ii) examine the implications of activity-based costing for Abkaber plc, and in so doing evaluate the
issues raised by each of the directors. Refer to your calculations in requirement (a) above where
appropriate. (12 marks)
