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The first requirement being that there is someone trying to send a message and someone expecting to receive it may at first seem obvious, however in practice it is probably the most violated requir...
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Contents Contents................................................................................................................2 Synopsis:............................................................................................................... 3 Answers................................................................................................................. 4 Charges for 40% mark on and Product to be dropped ........................................ 4 Recalculation of allocation rates if additional products are to be dropped .........5 What is going on? .............................................................................................. 6 Differentiation between variable and fixed costs and maximization of contribution ........................................................................................................ 7 Modified Cost system I........................................................................................ 7 Modified Cost System II...................................................................................... 9
Camelback communications Synopsis: About the company: •
Manufactures radio & television antennas
•
4 distinct product lines 1. Rabbit ear antennas 2. Dipole antennas for FM & TV reception 3. Rotators for the dipole line. 4. 2 electronic antennas;1 for FM & other for TV
•
Last 5 years, doubled the number of products offered, expanded the production facility twice & recently introduced the electronic antenna line.
•
President Lincoln McDowell concerned about its ability to cost products accurately.
•
Some products profitable whereas others impossible to manufacture at a profit.
•
Cost accounting system at fault.
Glenn Peterzon, a management consultant’s observations about the company’s cost system: •
Existing cost system is simple.
•
It used a single burden rate for all overhead costs.
Burden Rate =
Budgeted Variable + Fixed Overheads Number of Direct Labour Hours
Standard Cost = Direct Labour Cost + Direct Material Cost (Direct Labour Hours * Burden Rate)
To illustrate the problem to the management he developed a Four Product Model.
He calculated the direct labour allocation rate that the existing single burden rate cost system would generate assuming the production to be maximum possible & taking direct labour hour cost to be $5.
•
After computing the standard cost, selling price was calculated on the basis of 40% mark-on.
•
•
Industry selling prices were different as they were established using the actual production costs & a 40% mark-on.
•
On comparing the industry prices to the firm’s costs profitability was determined.
•
The products with a mark-on of less than 25% were discontinued.
•
Because of this the resulting product mix differed from the starting mix which led to recalculation of allocation rate per hour to determine if it had been affected.
Answers Charges for 40% mark on and Product to be dropped Variable Product Overhea d B C D
New Alocatio n Rate: Variable Overhea d Fixed Overhea d Total Labour Hours Allocatio n Rate/Ho ur
Labour Variable Hours Per Overhead Unit Per Unit 1 7.5 3 5 2 7.5
27500
45000 72500 7000
10.36
Total Labour No. Of Units Hours Total ($) 2000 2000 15000 1000 3000 5000 1000 2000 7500 Total
Product Material Labour
B
C
D
5 5
10 15
5 10
Allocate d Cost
10.36
31.07
20.71
Standard Cost
20.36
56.07
35.71
8.14
22.43
14.29
28.50
78.50
50.00
27.5 11
42.5 17
35 14
38.5
59.5
49
18.14
3.43
13.29
89.12
6.11
37.20
40% Mark On Selling Price Standard Cost Mark On Standard Selling Price Profit % Markup
Hence Product C will be discontinued
Recalculation of allocation rates if additional products are to be dropped Variable Product Overhea d B D
New Alocatio n Rate: Variable Overhea d Fixed Overhea d
Labour Hours Per Unit 1 2
30000
45000
Variable Overhead Per Unit 7.5 7.5
Total Labour No. Of Units Hours Total ($) 3000 3000 22500 1000 2000 7500 Total
Total Labour Hours
75000 5000
Allocatio n Rate/Ho ur
Product Material Labour
15.00
B
D 5 5
5 10
Allocate d Cost
15.00
30.00
Standard Cost
25.00
45.00
10.00
18.00
35.00
63.00
27.5
35
11
14
38.5
49
13.50
4.00
54.00
8.89
40% Mark On Selling Price Standard Cost 40% Mark On Standard Selling Price Profit % Markup
Hence product D is to be discontinued.
What is going on? Table A in the case gives the actual cost incurred during the production of the items A, B, C and D. Camelback Communications is calculating the allocation rate by adding together all the fixed and the variable cost for all the products together and then dividing them by the total labour hours. Now this method of calculating the allocation rate is incorrect because •
Fixed overhead per product is fixed irrespective of the labour hours
•
•
Fixed overhead is being divided between the 4 products in a faulty way because of including it in the allocation rate. Also, the variable overhead that is calculated in this method is not correct because the variable overhead per unit is different for different products.
Hence we can see the variation between the industry selling prices and that given by the costing system in place. Consequences of this costing system are as follows: Because of wrong allocation of costs, we find that certain products are gaining because the costs that should be truly attributed to them are being given to other products and vice versa. Therefore the products whose costs are getting increased due to the wrong allocation are showing less than desirable profits although there mark up is the same. Eg. The actual cost that should be attributed to A is $70, but due to the faulty cost system a cost of $85 is getting attributed to it. Now the Selling price calculated based on the industry standard remains the same and hence although the mark up is 40%, we seem to get a lower mark up of 15% which leads to an equally profitable product being discontinued.
Differentiation between variable and fixed costs and maximization of contribution Modified Cost system I If fixed costs are allocated using the current costing system and variable costs are correctly attributed then, Variable Product Overhea d A B C D
New Alocatio n Rate:
Labour Hours Per Unit 6 1 3 2
Total Labour No. Of Units Hours 1000 2000 1000 1000 Total
6000 1000 3000 2000 12000
Fixed Overhea d
45000
Labour Hours
12000
Allocatio n Rate/Ho ur
Product Material Labour Variable overhea d
3.75
A
B
C
D
15 30
5 5
10 15
5 10
15
7.5
5
7.5
Allocate d Cost
22.5
3.75
11.25
7.50
Standar d Cost
82.5
21.25
41.25
30
33
8.5
16.5
12
115.5
29.75
57.75
42
70 28
27.5 11
42.5 17
35 14
98
38.5
59.5
49
15.5 18.78787 879
17.25 81.1764705 9
18.25 44.2424242 4
19 63.33333 333
40% Mark On Selling Price Standard Cost Mark On Standar d Selling Price Profit % Markup
From the above, we can see that there is very little change in the balancing of the costs of the product and even in this case product A would get discontinued. Also, it is clearly evident from this that the wrong allocation of variable cost has
a much greater hand in the deviation of the costs from their true value as compared to fixed costs.
