Alex plc is an established company which has three product lines P1, P2 and P3. Since its creation the company has been using a single direct labour cost percentage to assign overhead costs to products. Prices for the products are established by adding 25% to the total product cost. P1 and P2 are established products but have been giving concern because Alex has been losing market share to competitor companies. As a result a new product, P3, was developed and this surprised the management with the amount of additional business it quickly attracted. The management team have also noticed the significantly increasing overhead costs and they have become convinced that the costing system is in need of some development. A team, led by the management accountant, was established to develop an improved system of costing based on activities. The team spent several weeks collecting data (see tables below) for the different activities and products.
For the current accounting period, given in the tables below is data on Alexâ€™s three product lines and the overhead costs applicable to them:
|Production volume||3,750 units||6,250 units||2,000 units|
|Material cost per unit||Â£18||Â£25||Â£16|
|Direct labour cost per unit||Â£4||Â£8||Â£6|
|Machine hours (per unit)||0.4||0.4||0.4|
|Materials movements (in total)||15||25||40|
|Proportion of engineering work (%)||30%||20%||50%|
|Orders packed (in total)||3||7||20|
- a) Calculate the overhead rate, the unit costs and the projected prices of the three products, using the existing costing system based on direct labour cost.
- b) Identify for each overhead activity cost pool, an appropriate cost driver from the information supplied and then calculate the product unit costs using a system that assigns overheads on the basis of activities.
- c) Comment on the results of the two costing systems in (a) and (b) and the extent to which they explain the managementâ€™s concern about the three products.
a and b.
XYZ is a company with a consistent growth record and a reputation of average quality. The company has recently created a new division and commenced the supply of plastic components to the motor industry. Senior managers were surprised by the level of complaints and rejects that this sector of their business attracted. They were concerned about this because of the effect it may have on their reputation and future sales within the sector. The management established a cross functional team to address their quality performance, to collect data and to report on their progress in the division so far. They also employed a consultant to advise on the system and they requested a quarterly cost of quality report for the first three quarters of 2019. Their objective was to determine where quality costs were being incurred and what they needed to do in order to improve quality in the future. The quality cost items for the first three quarters are summarised below.
Quarterly Quality Cost Items for the first three quarters of 2019
January April July
Cost item â€“March -June -Sept
|Quality training workshops||10,800||25,200||52,200|
|Inspecting for quality standards||38,700||106,200||123,300|
|Planning the quality system||21,600||37,800||36,900|
|Inspection of purchases||103,500||147,600||172,800|
|Fee of quality consultant||16,200||35,100||53,100|
|Cost of raw material waste||56,700||40,500||27,900|
|Warranty repair service||100,800||77,400||58,500|
|Lost sales due to unresolved problems||211,500||188,100||125,100|
|Obtaining customer feedback||28,800||77,400||98,100|
The company achieved a sales revenue of Â£5,043,600 in the first quarter; Â£5,291,100 in the second quarter; and Â£6,278,400 in the third quarter.
- Explain briefly why management might need accounting for quality and comment on the benefits that could be derived from quality cost reporting.
- Analyse the information in the table above to form a report after rearranging it into the four categories of prevention, appraisal, internal failure and external failure costs. Interpret your analysis pointing out any key features.
- A further detailed analysis by the companyâ€™s design engineers revealed that the casings in which the plastic components are transported to customers are often subject to mishandling in transit. One way of reducing this quality problem is to redesign and strengthen the casings and the containers used to transport to better withstand mishandling during transportation. Redesign will cost Â£90 per plastics components on all sales in 2020
XYZ expect to sell 10,000 units of plastic components in 2020 and earn an annual revenue of Â£30 million. The contribution margin on plastics components in 2020 is expected to be 45% of sales.
The design engineers believed that, even if it is able to achieve improvements in quality, it will only save 50% of repairs and rework fixed costs.
The breakdown of the expected variable and fixed costs of repair and rework are presented below:
Costs of rework for each reworked plastic components are as follows:
(including direct materials, direct labour rework and supplies) 84
Allocated fixed costs
(equipment, space and allocated overhead 56
Total cost 140
Costs of repair for each repaired plastic components are as follows:
Variable Fixed Total
costs costs costs
Â£ Â£ Â£
Customer support costs 45 60 105
Transport costs 30 40 70
Warranty repair costs 55 100 155
If they redesign and strengthen the casings and the containers used to transport the plastic components they sell in 2020, they expect they will need to rework 1,350 fewer plastic components, carry out repairs on 2,000 fewer plastic components and, expect to sell an additional 450 plastic components in that year.
Compute the costs and benefits that will occur in 2020 if XYZ redesign and strengthen the casings and the containers used to transport the plastic components and comment on any qualitative aspects that may apply. How can the accountant contribute to the profile of a quality initiative?
Humber Limited is a merchandise company structured on a geographical location basis. Division A is located in Edinburgh and is responsible for all the companyâ€™s dealings in the North. Division B is located in Essex and is responsible for the Eastern operations. Division C is located in Bicester and is responsible for all Southern operations; and division D located in Bristol, is responsible for the companyâ€™s activities in the West. Humber Limited treats the four divisions as investment centres with considerable authority over decision making decentralised to division managers. Every month the divisions prepare an operating statement which they submit to the Head Office in London. Humber Limited puts considerable emphasis on financial performance of the divisions.
The following is a monthly Operating Statement, providing indicative performance, and Balance Sheet extracts of the four divisions:
|Division A||Division B||Division C||Division D|
|Less variable costs||2,484||2,244||18,522||1,100|
|Less fixed costs||3,114||1,596||3,477||1,128|
|Divisional fixed assets:||Â£,000||Â£,000||Â£,000||Â£,000|
|At original cost||58,560||7,560||60,030||3,780|
|At written down value||31,320||6,720||45,780||3,360|
|Working capital||14, 400||1, 800||10,500||1,900|
The company operates with a target return on capital of 15% per annum. At present the performance of each division and its management is assessed against this target using return on investment (ROI) based on assets at original cost plus working capital. The company applies straight line depreciation to fixed assets.
- From the above data calculate the annualised Return on Investment (ROI) for each of the four divisions in line with the companyâ€™s current practice. Briefly compare and comment on the performance of the four divisions
- Compute the annualised ROI and the annualised residual income (RI) value measures for the four divisions. In both cases use fixed assets based on their written down value plus working capital. Comment on your observations.
- Determine the possible advantages to Humber Limited of using Economic Value Added for performance measurement, in comparison to their existing Return on Investment and Residual Income approach.
Xarah is a manufacturing company which produces zinc sheet. Xarah has two divisions. The Rolling Division makes zinc sheets, which are then transferred to the Slitting Division. The Slitting Division process the zinc sheets further and sell the zinc sheets to customers at a price of Â£300 per sheet. The Rolling Division is currently required by Xarah to transfer its total yearly output of 400,000 zinc sheets to Slitting division at 110% of full manufacturing cost. Unlimited quantities of zinc sheets can be purchased and sold on the outside market at Â£180 per sheet. To sell the zinc sheets it produces at Â£180 per sheet on to the outside market, the Rolling Division would have to incur variable marketing and distribution costs of Â£10 per zinc sheet. Similarly, if the Slitting Division purchased zinc sheets from the outside market, it would have to incur variable purchasing costs of Â£6 per sheet.
The following table provides the manufacturing costs per sheet in the Rolling and Slitting Division for the year 2019.
Direct materials Â£24 Â£12
Direct manufacturing labour costs 32 40
Manufacturing overhead costs 64 50
The manufacturing overhead costs are; 25% fixed and 75% variable for Rolling Division and 60% fixed and 40% variable for Slitting Division.
Xarah reward each division manager with a bonus, calculated as 1% of divisional operating profit (if positive).
- a) Calculate the operating profits for the Rolling and Slitting Divisions for the 400,000 zinc sheets transfer under each of the following transfer-pricing methods
(i) Market price
(ii) 110% of full manufacturing costs.
- b) Calculate the amount of bonus that will be paid to each division manager under each of the transfer-pricing methods in (a) and determine which method each division manager will prefer.
Justify your answer showing the arguments each manager can make to support the transfer-pricing method s/he prefers?
- c) From the standpoint of Xarah as a whole, what quantity of zinc sheet should the Rolling Division transfer to Slitting Division, assuming the Rolling Division is not required to transfer its yearly output of 400,000 zinc sheets to Slitting Division?
- d) Suppose each division manager acts autonomously to maximise the divisionâ€™s operating profit. What range of transfer prices will result in managers of the Rolling and Slitting Divisions achieving the actions determined to be optimal in requirement a).
- e) Briefly discuss the objectives of international transfer pricing and the relationship between transfer pricing and corporate strategy.