Question

Question 3. Activity-Based Costing (ABC)   

This question builds on prior studies and relates to learning material and objectives from Topic 6.

Jupiter Australasia Ltd owns Victory Mowers a manufacturer of gardening equipment which is sold domestically within Australia and to an increasing export market. Victory Mowers manufactures two different models of lawnmowers: the cheaper ‘Lawnmaster’ and the environmentally-friendly and more expensive ‘Green Machine’. A dispute has arisen between senior management at Victory Mowers over the strategic direction of the company. The CEO of Victory, a former marketing executive, wishes to focus more strongly on developing the environmentally friendly ‘Green Machine’ as he believes it has a higher gross margin and is more profitable than the ‘Lawnmaster’. The ‘Green Machine’ is sold as a premium product through specialist mower dealers while the mass produced ‘Lawnmaster’ is sold as a basic model through the Bunnings Hardware chain. In contrast to her CEO the divisional management accountant has argued that the standard costing system is not suited to these products and may produce misleading results.

The Strategic Management Committee of Jupiter Australasia Ltd has asked for an analysis of the costing system to provide advice regarding the two models. Currently, Victory Mowers operates a standard costing system where identifiable direct costs are charged to each product and manufacturing overheads are allocated using direct labour hours (DLH) as the sole cost driver.

2020 Sales and Cost estimates	Lawnmaster	Green Machine
Forecast Sales (Units)	200,000	25,000
Selling price per unit($)	$200	$300
Prime Costs per unit	$100	$150
DLH per Unit	2.5	2.5

The following data is provided for the 2020 financial year:

The activity costs budgeted for overhead for the 2020 financial year and related activity cost drivers were as follow:

OH Activity	OH Cost	Cost Driver	Amount of Cost Driver
			Lawnmaster	Green Machine
Set Ups	$493,750	Number of Set ups	25	50
Laser Cutter	$1,100,000	Machine Hours	30,000	10,000
Machining	$2,100,000	Machine Hours	50,000	15,000
Assembly	$1,250,000	Labour Hours	50,000	25,000
Packing	$1,800,000	Number of Orders	1000	500

Required:

(a) Using the current standard costing method of applying overhead using direct labour hours develop a spreadsheet to calculate for each model the expected:

i. Gross Profit per unit,

ii. Gross Profit margin ($GP/$Sales),

iii. Total Gross Profit per Model, and

iv. Total Firm Gross Profit.

(b) Using the overhead activity and cost data provided conduct the same analysis utilising Activity Based Costing (ABC) techniques to allocate activity-based costs and again calculate for each model the expected:

i. Gross Profit per unit,

ii. Gross Profit margin ($GP/$Sales),

iii. Total Gross Profit per Model, and

iv. Total Firm Gross Profit.

(c) What advice would you give the Strategic Planning Committee and the management of Victory Mowers regarding the appropriate costing system and the comparable profitability of the two products? Provide an analysis explaining the reasons for the different outcomes achieved between using Standard Costing overhead allocation and ABC overhead allocation. (150-200 words)

Answer 1

I would adviced to use the Activity Based Costing (ABC) techniques to allocate overhead between the two models.

Gross profit margin of Lawnmaster model and Green Machine model are 38.40% and 21.93%, respectively.

Product Lawnmaster has a better gross profit margin.

Advantage

ABC method provide accurate cost per unit compared to traditional method.

ABC method helps in Cost control.

Diadvantage

ABC method is very costly and time consuming for business.

ABC method is not effective when Proper cost driver not selected.