Yani PLC is a growing logistics and distribution business which operates within a supply chain between component

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Question:

Yani PLC is a growing logistics and distribution business which operates within a supply chain between component manufacturers and their customers. They buy large quantities of various components, sort, repack and deliver to individual customer requirements. Customers are charged the list price of the components ordered plus a charge for selling and admin overheads. The selling and admin overheads are distributed using a simple system based on a rate per order. The directors are concerned that their costing system has not kept pace with the company’s growth. They set up a task force headed by the chief management accountant to investigate the costing systems and suggested alternative methods. After an initial analysis, the task force proposed two alternative costing methods. The first method is to change the costing method to an absorption rate calculated based on the budgeted annual selling and admin costs and the budgeted annual total list price of the components supplied. The second method is to focus on an activity-based system. An analysis of customers has revealed that many customers place frequent small orders with each order requesting a variety of components. The task force examined more carefully the nature of its selling and distribution costs, and the following data have been prepared from the budget for next year:

Total list price of components supplied £36 million

Number of customer orders 36,000

Selling and admin costs £000 Cost driver

Invoice processing 1,680 See note 1

Packing 960 Size of package –see Note 2

Delivery costs - loading 360 See Note 3

Delivery costs – mileage 1,260 See Note 3

General facility overheads 780

Total overheads 5,040

Notes:

Each invoice has a different line for each component ordered. There are 126,000 invoice lines each year. It is estimated that 25% of invoice processing costs are related to the number of invoices and 75% are related to the number of invoice lines.

Packing costs are £35 for a small package and £42 for a large package.

The delivery vehicles are always filled to capacity for each journey. The delivery vehicles can carry either 6 large packages or 12 small packages of components (or appropriate combinations of large and small packages). It is estimated that there will be 6,000 delivery journeys each year, and the total delivery mileage that is specific to particular customers is estimated at 1,050,000 miles each year. The delivery costs have been analysed into two cost pools, one involves loading the delivery vehicles and are related to each journey; the other is related to delivery distance in miles to customers.

There are also some general facility overheads.

Each order will be shipped in one package and will result in one delivery to the customer with one invoice.

The task force advised for two typical orders to be costed using next year’s budget data, using the current method, the proposed method based on component value and the proposed activity-based costing approach. Details of two typical orders are shown below:

Order M Order X

Lines on invoice 4 10

Package size Small Large

Delivery distance (miles) 8 40

List price of components supplied (£) 1,500 600

Required:

a) Determine the overhead rates that would apply and thus calculate the charge for selling and distribution overheads for Order M and Order X using

(i) the current system;

(ii) the system using component value, and

(iii) the activity-based costing approach.

(30 marks)

b) Assess the benefits and limitations of the proposed systems, including any assumptions in your analysis.

(10 marks)

c) Discuss how the activity-based costing (ABC) information can be used to enhance Yani PLC’s operations. Your discussion should include various areas ABC information can be used to assist managers in planning and decision making.