Question 3 (Activity Based Costing)

AutoParts Ltd manufactures various components and sub-assemblies for a number of different car manufacturers. Jobs completed for car manufacturers are costed on the basis of the direct materials and direct labour used, plus an allocation of manufacturing overhead expenses. Overheads are allocated to jobs on the basis of direct labour hours. For the 2018 year the overhead allocation rate is 22 per direct labour hour. AutoParts has recently employed a new management accountant, Nora Green, who has suggested that the company should introduce an Activity Based Costing (ABC) system to allocate overheads to jobs. Nora has determined that four major activities are required for all jobs. Activities, cost drivers and cost driver rates determined by Nora for 2018 are as follows: Activity Cost Driver Cost Driver Rate Materials handling Number of parts 0.85 Machine set-up Number of set-ups 500.00 Assembling Assembly hours 80.00 Shipping Number of shipments 1,500.00 AutoParts has recently been awarded two new sub-assembly contracts, one from Ford and one from Porsche. AutoParts estimating department has determined the following requirements for each of the contracts: Ford Porsche Number of parts 15,000 2,000 Number of set-ups 6 4 Number of assembly hours 1,500 200 Number of shipments 1 1 Total direct labour hours 8,000 600 Number of finished sub-assemblies 100 10 Direct materials cost 220,000 30,000 Direct labour cost 160,000 12,000

Required: (a) Calculate the cost per finished sub-assembly for each of the contracts, using AutoParts original costing system.

(b) Calculate the cost per finished sub-assembly for each of the contracts, using Nora Greens ABC system.

(c) Which of AutoParts two costing systems more accurately allocates to jobs the cost of the resources consumed to produce them? Give a full explanation for your answer.

d) From time to time AutoParts uses a reliable auto engineering company as a sub-contractor. This company has offered to produce both jobs for 5,400 per sub-assembly. AutoParts may outsource either the Ford job only, or the Porsche job only, or both jobs.

1. What decision will AutoParts take if they base their decision on the original costing system?

2. What decision will AutoParts take if they base their decision on the ABC system?

3. If Autoparts decides to outsource one of the jobs, what will the effect be, in the short to medium term, on their current level of overhead costs? Explain briefly.

In each of cases (i) and (ii), you should briefly explain how you arrived at your conclusion. You should also indicate which costing system produces the best result for the company.