Analysis on Activity Based and Volume Based Costing Systems

Analysis on Activity Based and Volume Based Costing Systems in $19 Only

You have just been hired as an accountant for the PCB (Printed Circuit Board) Department of LifeSung Corporation. LifeSung is a highly diversified organisation headquartered in Taiwan, with interests in healthcare, electronics, construction, insurance and shipbuilding. The PCB Department is part of the Electronics Division of LifeSung and produces circuit boards mainly for use in alarm systems. However, there are other circuit boards that are produced for other electronic devices, but these make up a small percentage of total sales.

Three of the circuit boards produced by the PCB Department make up the bulk of the department’s sales: The first, Advanced Circuitry, has been the mainstay of the department for several years. The market for this board is very competitive and price sensitive. The second, Boosted Circuitry, was a new board introduced two years ago. It is a medium range circuit board that had slightly more advanced features. This board has been used in alarm systems that could be partly modified by customers to suit their requirements. The third circuit board, Customised Circuitry, is a top-of-the-range circuit board that allowed full configuration of the alarm system by customers. This board incorporates the latest technology and the price matches the capabilities of the circuit board.

When you arrived at work for the first time, you learnt that the previous accountant had quit two weeks prior and had not left much information behind. Frank Chan, the manager of the PCB Department, provides you with an abbreviated income statement and states: “The previous accountant did not leave much information behind when she quit. This is as much as I have. The income statement was for last month, but I cannot understand anything from it. I need you to decipher it for me.” He then hands you the income statement. “I need you to work out for me how much each of these circuit boards is costing me. “

                 AC, BC and CC
Income Statement for February 20×4
Revenue $2,086,000
COGS $1,920,000
Gross Profit $166,000
Selling and Admin Expenses $70,000
Income before Tax $96,000
Income Tax (30%) $28,800
Net Income $67,200

With the income statement in hand, you proceed to gather more information. You work out the following:

a. The income statement only refers to the three main circuit boards (Advanced Circuitry, Boosted Circuitry and Customised Circuitry) and does not include all the other circuit boards that PCB produces and sells. You further establish that in February, 3,000 units of Advanced Circuitry, 1,000 units of Boosted Circuitry and 500 units of Customised Circuitry were produced and sold. The selling prices were $432, $450 and $620 respectively.

b. The requirements for the three circuit boards of material and time as listed:

Advanced Boosted Customised
Direct Materials (grams) 50 75 100
Direct Labour (hours) 2 1 0.5
Machine Time (hours) 1 2 4

The current volume-based costing system uses three types of overhead: Labour related overhead, machine related overhead and variable overhead. Labour related overhead is applied on the basis of direct labour hours. Machine related overhead is applied on the basis of machine time and variable overhead is applied on the basis of units produced. In February, the total labour related overhead applied was $435,000, machine related overhead applied was $560,000 and the variable overhead applied was $180,000.

c. The average cost of direct materials was $600 per kilogram and the wage rate was $80 per hour.

With the information in hand, you were about to begin computing the cost of each of the circuit boards when you received a call. It was Frank Chan. “Look,” he says. “I need you to tell me whether we are making money on these products. Head office normally demands a 20% mark-up on the cost of each product. Are we meeting those targets? Get me the information fast as I have a meeting with Head Office next week.” With that he hung up.

Just as you were about to start work on the data, Frank rang again. “I have heard from the sales people that the Advanced is not selling as well as it could. They told me that we are pricing it too high. How is that possible? I was told that we were barely breaking even on this. Furthermore, Boosted and Customised sales are shooting through the roof. We had to raise prices of the Customised to cool the market. Not sure if this is working as yet. Maybe we should also raise the price of Boosted. No one else seems to want to sell anything like the Boosted or the Customised. Maybe we are just way ahead of our competitors in terms of our technology. I reckon we should just focus all our efforts on the Boosted and the Customised and just forget about the Advanced. Get me the information pronto.”

“Well, that’s a good start,” you think to yourself as you prepare to get down to work. And the phone rang again. And again it was Frank. “Anthony from the Assembly Department has just informed me of this concept that they were working on with Jenny (the previous accountant). He says it’s called “ABC something or other” that allowed us to work out our product cost better. I do not know what he is on about but if it helps us, I need to know about it. And if it does what Anthony thinks it would do, then maybe I should consider switching to the ABC-thing. Anthony has all the information with him that Jenny left behind. Anthony is waiting there for you, so do this now. He will be going on holidays tomorrow and I cannot afford to wait till he gets back. I need you to get down there, go through the information and tell me if it is useful. And I need it fast, together with what I asked you to do previously!”

 You get down to the Assembly Department and Anthony is waiting in his office for you with some information. “Jenny and I were working on this Activity-based costing system. We felt that it would be worthwhile to examine this as ABC looks at product costs on the basis of activities involved in their production rather than just volume. ABC integrates the cost of all activities into individual product costs rather than including them as overheads, as I am sure you are aware.” To which you nod vigorously. “Well,” Anthony continued, “I will give you these and you can explain them to Frank. And by the way, we have identified all the cost pools and cost drivers for you, based on February’s data. Hopefully, this will help you plan next month’s expenditure and activities. Good luck.”

As you leave, you look at the pile of notes made by Anthony and Jenny and are thankful that they have summarised everything onto one page (see Appendix A). Looks like it is now time for you to get down to work!

REQUIRED:

Prepare a 10-page report for Frank Chan that discusses the following:

a) The current unit product cost for Advanced Circuitry, Boosted Circuitry and Customised Circuitry. Show your calculations in the appendix up to 2 decimal points

b) The new unit product costs of the three circuit boards using Activity-based costing. Show all calculations in the appendix up to 2 decimal points.

c) Plausible reasons why Advanced Circuitry is doing badly. Identify and discuss possible reasons why no one else is selling anything like the Boosted or the Customised and why sales of the Boosted and the Customised Circuitry are booming. Should Frank focus the attention of PCB on only the Boosted Circuitry and the Customised Circuitry?

d) The reasons for using Activity-based costing (ie the advantages of ABC over the current volume-based costing system).

e) Are there any limitations to ABC?

f) Compare the information derived from the volume-based system and ABC and make a recommendation on what the company should do.

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