Vijaya Publishing Co publishes two forms of book.
The company publishes a children’s book (CB), which is sold in large quantities to government controlled schools. The book is produced in only four large production runs but goes through frequent government inspections and quality assurance checks.
The paper used is strong, designed to resist the damage that can be caused by the young children it is produced for. The book has only a few words and relies on pictures to convey meaning.
The second book is a comprehensive technical journal (TJ). It is produced in monthly production runs, 12 times a year. The paper used is of relatively poor quality and is not subject to any governmental controls and consequently only a small number of inspections are carried out. The TJ uses far more machine hours than the CB in its production.
The directors are concerned about the performance of the two books and are wondering what the impact would be of a switch to an activity based costing (ABC) approach to accounting for overheads. They currently use absorption costing, based on machine hours for all overhead calculations. They have accurately produced an analysis for the accounting year just completed as follows:
$ per unit $ per unit
Direct production costs:
Paper 0.75 0.08
Printing ink 1.45 4.47
Machine costs 1.15 1.95
Overheads 2.30 3.95
Total cost 5.65 10.45
Selling price 9.05 13.85
Margin 3.40 3.40
The main overheads involved are:
Overhead % of total overhead Activity driver
Property costs 75.0% Machine hours
Quality control 23.0% Number of inspections
Production set up costs 2.0% Number of set ups
If the overheads above were re-allocated under ABC principles, then the results would be that the overhead allocation to CB would be $0.05 higher and the overhead allocated to TJ would be $0.30 lower than previously.
A. Explain why the overhead allocations have changed in the way indicated above.
The directors are keen to introduce ABC for the coming year and have provided the following cost and selling price data:
- The paper used costs $2 per kg for a CB but the TJ paper costs only $1 per kg. The CB uses 400g of paper for each book, four times as much as the TJ uses.
- Printing ink costs $30 per litre. The CB uses one third of the printing ink of the larger TJ. The TJ uses 150 ml of printing ink per book.
- The CB needs six minutes of machine time to produce each book, whereas the TJ needs 10 minutes per book. The machines cost $12 per hour to run.
- The sales prices are to be $9.30 for the CB and $14.00 for the TJ.
As mentioned above there are three main overheads, the data for these are:
Overhead Annual cost for the coming year ($)
Property costs 2,160,000
Quality control 668,000
Production set up costs 52,000
The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20 times.
Vijaya Publishing will produce its annual output of 1,000,000 CBs in four production runs and approximately 10,000 TJs per month in each of 12 production runs.
B. Calculate the cost per unit and the margin for the CB and the TJ using machine hours to absorb the overheads.
C. Calculate the cost per unit and the margin for the CB and the TJ using activity based costing principles to absorb the overheads.