TUTORIAL QUESTIONS PRACTICE PURPOSES
QUESTION 1
C. Ltd. manufactures and sells several types of consumer products. Competition
is intense and product lifecycles are short, so it is important for the company to
make the right decisions when considering the introduction of possible new
products. The company’s research and development (R & D) staff recently
identified two new product ideas.
Following consultation between R & D, Production and Marketing staff, the
following estimates of production times and quantities were arrived at:
Product X Product Y Product Z
Production and sales, per month 25,000 units’ 10,000 units 20,000
units
Machine hours (MH), per unit of output 5 MH 2 MH 10 MH
The company’s Management Accountant consulted extensively in the
organisation in order to arrive at estimates of the activity levels and overhead
costs associated with the production of the above outputs. It was estimated that
monthly production would involve a total of 1,000 production set-ups (at a total
cost of $1,200,000) and 8,000 materials movements (at a total cost of
$600,000). In addition, the electricity consumed in running the production
equipment was estimated to cost $2 per MH.
A target costing task force, consisting of representatives of all of the functional
management departments in the company as well as several accounting staff,
determined that none of the three products was likely to be adequately
profitable given the expected market conditions and the cost information
presented above.
Consequently, the target costing task force asked the R & D staff whether
changes to the designs of any products could be made which would have the
effect of simplifying the production process without adversely affecting the
usefulness and attractiveness to the customer of the finished product. The
following is a summary of the reductions in the activity levels associated with
each product as a result of the design changes which the R & D staff proposed:
Product X Product Y
Product Z
Reduction in number of production set-ups, per month 20 15
None
Reduction in number of materials movements, per month 200 80
None
Reduction in MH, per unit of product None None
0.25
REQUIRED:
(a) Calculate the total reduction in total monthly costs from implementing the
design changes proposed by the R & D staff.(8 marks)
(b) Assuming that the proposed design changes are implemented, calculate the
reduction in the unit cost of each of the three products in each of the following
circumstances:
If overheads are traced to products using activity-based costing (ABC).
If overheads are allocated to products on the basis of the number of units of
output. (6 marks)
(c) Now assume that the company’s Chief Executive has decided that each
product should be introduced only if the changes proposed by the R & D staff
would lead to cost savings of at least the following magnitudes:
Product X: $1.40 per unit Product Y: $2.00 per unit Product Z: $1.00 per unit
Using this additional information, and the results of your calculations in part (b),
explain why it is essential for C Ltd. to use ABC when applying target costing
analysis to decisions about whether or not to introduce new products. (6 marks)
QUESTION 2
L Ltd. manufactures a range of products, most of which have short product
lifecycles. Research and development staff recently designed three new products
which would be manufactured in a single production cell of the company’s
factory. The combined monthly manufacturing overhead costs of the three
products are summarised as follows:
Production set-ups (10 per month) $2,000
Materials movements (400 per month) $18,000
Repairs (4,000 per month) $30,000
Total manufacturing overheads per month $50,000
The following information is available concerning the three new products:
Product A Product B Product C
Production & sales, per month 2,000 units 5,000 units 1,000
units
Direct labour hours per unit 6 4 8
The company’s target costing task group expressed the view that the new
products would not be profitable given the likely market prices and the cost of
manufacturing the products using the proposed design. In response, the product
designers indicated that no design changes were possible in relation to Products
A or B, but that changes in the design of Product C would bring about the
following reductions in the amount of monthly activity involved in manufacturing
that product without compromising either the quality or quantity of output:
Production set-ups Materials movements Repairs
2 per month 100 per month 1,000 per
month
REQUIRED:
(a) Calculate the reduction in the cost per unit of each of the three products
which would occur as a result of the design changes to Product C, in each of the
following circumstances:
• If manufacturing overheads are traced to products using activity-based costing
(ABC);
• If manufacturing overheads are allocated to products on a direct labour hour
basis.
(10 marks)
(b) Discuss the view that an ABC system is essential for the implementation of
target costing. Use the case of L Ltd. to illustrate your answer. (5 marks)