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Wheels assembles three types of motorcycle at the same factory: the 50cc Sun; the 250cc Shine and the 1000cc Star. It sells the motorcycles throughout the world. In response to market pressures Wheels has invested heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the size of its workforce.

Historically, the company has allocated all overhead costs using total direct labour hours, but is now considering introducing Activity Based Costing (ABC). Wheels's accountant has produced the following analysis.

Annual annual selling. raw mat cost

output direct. ($per unit) ($per unit)

(units) labour hrs

Sun. 2,000 200,000. 4,000. 400

Shine 1,600 220,000. 6,000. 600

Star 400. 80,000. 8,000. 900

The three cost drivers that generate overheads are:

deliveries of motorcycles to retail showrooms Set-ups the number of times the assembly line process is re-set to accommodate a production run of a different type of motorcycle Purchase orders the number of purchase orders.

Strategic Management Accounting (June 2020) Page 1 of 3 MAA

Deliveries to retailers the number of

The annual cost driver volumes relating to each activity and for each type of motorcycle are as follows:

No. of No. of. No. of

Deliveries. set ups. purchases

Sun 100. 35. 400

Shine 80. 40. 300

Star. 70. 25. 100

The annual overhead costs relating to these activities are as follows:

Deliveries to retailers $ 2,400,000

Set-up costs $ 6,000,000

Purchase orders. $ 3,600,000

All direct labour is paid at $5 per hour. The company holds no inventories.

At a board meeting there was some concern over the introduction of activity based costing.

The finance director argued: 'I very much doubt whether selling the Star is viable but I am not convinced that activity based costing would tell us any more than the use of labour hours in assessing the viability of each product.'

The marketing director argued: 'I am in the process of negotiating a major new contract with a motorcycle rental company for the Sun model. For such a big order they will not pay our normal prices but we need to at least cover our incremental costs. I am not convinced that activity based costing would achieve this as it merely averages costs for our entire production'.

The managing director argued: 'I believe that activity based costing would be an improvement but it still has its problems. For instance, if we carry out an activity many times surely, we get better at it and costs fall rather than remain constant. Similarly, some costs are fixed and do not vary either with labour hours or any other cost driver.'

The chairman argued: 'I cannot see the problem. The overall profit for the company is the same no matter which method of allocating overheads we use. It seems to make no difference to me.'

Required:

a) Calculate the total profit on each of Wheels's three types of product using each of the following methods to attribute overheads:

(i) the existing method based upon labour hours; and

(ii) activity based costing. (15 marks)

b) Write a report to the directors of Wheels, as its management accountant. The report should:

(i) evaluate the labour hours and the activity based costing methods in the circumstances of Wheels; and

(ii) examine the implications of activity based costing for Wheels, and in so doing evaluate the issues raised by each of the directors.

Refer to your calculations in requirement (a) above where appropriate.

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