Part I: Activity-Based Costing
1. Calculate the unit manufacturing costs for simple desk and corner workstation under ABC system.
Table1: Calculation of the Indirect Costs Allocated to the Products |
Activity | Total activity cost(1) | Practical capacity(2) | Cost driver rate(3)= (1)/(2) | simple desk | corner workstation |
| | | | Usage(4) | Costs(3)*(4) | Usage (5) | Costs(3)*(5) |
Design and plan the production process | $262,500 | 700 | $375 | 40 | 15,000 | 120 | $45,000 |
Make layered panels | $861,500 | 172,300 | $5 | 8520 | 42,600 | 17325 | $86,625 |
Handle material | $88,000 | 440 | $200 | 60 | 12,000 | 45 | $9,000 |
Setup machine | $40,000 | 1,600 | ...view middle of the document...
50, which is higher than the cost $935 under simple costing system (See Table3).
Identify the problem with simple costing and comment on how ABC system solve the problem
The simple costing system used only one allocation base, direct manufacturing labor hours, to allocate manufacturing overheads to different products. It assumes all products consume all resources in proportion to direct manufacturing labor hours. While the manufacturing processes and the products they produced are more complex. Sometimes, the direct manufacturing labor hour is not a cause-and-effect relationship with indirect cost. If we use it to allocate indirect cost, the indirect cost will be assigned inaccurately. As result, simple desk is over-cost while corner workstation is under-cost.
ABC system attempts to overcome this problem. ABC systems create homogeneous cost pools linked to different activities. For each activity-cost pool, ABC system seeks a cost allocation base that has a cause-and-effect relationship with costs in the cost pool. Therefore, the indirect costs will be assigned based on the consumption of resources to different products more accurately.
2. Based on your analysis for requirement 1, advise on the actions that EWF’s management team might take to improve the company’s profitability.
EWF’s management can use the information of the ABC system to make a better pricing decision to improve the company’s profitability. The manager may readjust the prices of simple desk and corner workstation.
Table4: Product profitability analysis(ABC system) |
| Simple desk(per unit) | Corner workstation(per unit) |
Full manufacturing costs | $257.5 | $1059.5 |
Markup (60%) | $154.5 | $635.7 |
EWF’s Selling price | $412 | $1695.2 |
Gross margin | 37.5% | 37.5% |
| | |
Competitors’ price | $420 | $1650 |
To set the prices of simple desk and corner workstation as manufacturing costs plus 60% markup (see Table4). The manager should sell simple desk at $412 which is lower than the competitors’ price, $420. It will increase the competitiveness and attract more customers. In addition, the gross margin is 37.5%. It is higher than the 35%, so it could cover all nonmanufacturing costs and earn a reasonable return for company.
As for the corner workstation, the price should be set at $1695.2 in order to earn 60% markup. However, the price is higher than the competitors’ price, $1650. Since the competition in the furniture industry is keen, the higher price, the more business will be lost. At least, EWF is required to set price same as the competitors’ $1650 to stay competitive in the industry. Even though, it cannot earn 60% markup, but till has 35.79% [(1650-1059.5) ÷ 1650] gross margin, which is higher than 35%. It is better to sets price at $1650 to earn few profits instead of setting higher price and earning high more gross profit per unit, but losing business.
In the conclusion,...