John Smith now tells you that the firm is considering a new export order for thr

Question

John Smith now tells you that the firm is considering a new export order for three months with a proposed selling price of £3 million. He provides you with the following information.

i. The order will require two types of material:

- Material X is in regular use by the firm. The amount of stock now held, when originally purchased, cost £0.85 million, but its standard cost is £0.9 million. The amount in stock is sufficient for the order. The current market price of material X to be used in the order is £0.80 million.

- Material Y is no longer used by the firm and cannot be used elsewhere if not used on the order. The amount in stock now held, originally purchased, cost £0.2 million although its current purchase price is £0.3 million. The amount of material Y in stock is only half the amount required on the order. If not used on the order, the amount currently in stock could be sold for £0.1 million.

ii. Direct labour of £1 million will be charged to the order. This includes £0.2 million for idle capacity, as a result of insufficient orders to keep the workforce fully employed. The firm has a policy of no redundancies, and spreads the resulting cost of the time across all orders.

iii. Variable factory overhead are expected to be £0.9 million.

iv. Fixed factory overhead are apportioned against the order at a rate of 50% of variable factory overhead.

v. No sales commission will be paid.

Question:

1) Perform a Contribution Margin Analysis based on opportunity costs and revenues

2) Prepare a brief report showing whether or not the new export order should be accepted or rejected and explain your decision.

3) General question: “ …To the extent that costs of activities are not, after all, direct costs, there is no reason to suppose that the allocation procedure by which they are determined is more accurate than any other“. (Armstrong, 2002:107)

Critically discuss the idea that ABC is a more accurate costing approach than traditional full (absorption) costing.

Present in detail the differences between ABC and traditional full (absorption) costing, and the main advantages and limitations of ABC implementation. Also explain how the organisational context influences the implementation of ABC as well as its consequences.

Explanation / Answer

Calculation of contribution :-

Contribution = Selling price - variable cost

Selling Price = 3 Million

Variable costs allocable to project (Amount in Millions)

Purchase Price for material X = 0.85

Utilisation of material Y = 0.2

Purchase of material Y = 0.3

Labour (Less idle cost) = 0.8 (1-02)

Total Variable O/H = 0.9

Total variable costs = 3.05

Contribtion = -0.05

2 ) Since the contribution is negative, this project should not be used. Further, material X can be utilised in other projects.

Also, since material Y shall not be used again by the company, benefit is less as compared to it's cost.

3) Standard and ABC costing are the two ways of allocating indirect cost to the products.

Benefits of ABC are :-

a) Standard costing assigns O/H on activities invloved in production based on some pre determined rate as compared to the ABC method where cost is allocated based on actual utilisation.

Hence, ABC is more accurate way of the allocation of such costs.

This may help loacte high impact areas and also redundant activities which can be brought down.

However, ABC costing is more complex in nature as allocating minute costs on various activities may be practically difficult. Hence, due to it's complexity ABC costing is difficult to implement.

Hence, if the costs involved are low, standard or historical basis of costing can be used.

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