Purchase Solution

# Product cost

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A company manufactures refrigrators for domestic use .There are three models: Lo ,Mid and Hi.The Models ,their quality and their price are aimed at different markets..Product costs arecomputed on ablanket (business-wide)overheadrate basis using a labour-hour method .Prices as a general rule areset based on cost plus 20 per cent. the following information is provided:

Lo Mid Hi

Material Cost(pound/unit) 25 62.5 105
Direct Labour hours(per unit) 1/2 1 1
Budget production/sales(unit) 20,000 1,000 10,000

The budgeted overheads for the business amount to 4,410,000 pound sterling. Direct labour is costed at 8 pounds an hour.
The business is currently facing increasing competition ,especially from imported goods .As a result ,the selling price of Lo has been reduced to a level that produces avery low profit margin.To address this problem,an activity -based costing approach has been suggested .The overheads are examined and these are grouped around main business activities of machining (2,780,000 pounds) ,logistics(590,000 pounds)and establishment (1,040,000 pounds)costs.It is maintained that these costs could be allocated based respectively on cost derivers of machine hours ,material orders and space,to reflect the use of resources in each of these areas.After analysis ,the following proportionate statisticsare available in relation to the total volume of products:

Lo Mid Hi
% % %
Machine Hours 40 15 45
Material orders 47 6 47
Space 42 18 40

As the mangement Accountant of this company do the following:
1-Calculate for each product the full cost and selling price determined by :'
a- The original costing method
b- The activity -based costing method
When the figures are computed ,prepare adetailed report for your boss that includes a discussion of the following information:

-An analysis of implications involved with each of the two costing systems and subsequent price differences.

-An analysis of each costing system ,including a recommendation of which cost system you would recommend or any changes you would suggest to the pricing strategy .

-an analysis of the business/strategic options that exist for your organization in light of the new information ,including possible pricing strategies.

The report should be preparedas a concisebusiness report to your supervisor that includes both the figures computed and the analysis of the situation .This

##### Solution Summary

The solution explains the calculation of product cost using traditional costing and activity based costing

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