Professional Documents
Culture Documents
COMMUNICATIONS
Management Accounting
2008
Contents
Contents................................................................................................................ 2
Synopsis:............................................................................................................... 3
Answers................................................................................................................. 4
Charges for 40% mark on and Product to be dropped........................................4
Recalculation of allocation rates if additional products are to be dropped.........5
What is going on? ..............................................................................................6
Differentiation between variable and fixed costs and maximization of
contribution........................................................................................................ 7
Modified Cost system I........................................................................................7
Modified Cost System II......................................................................................9
Camelback communications
Synopsis:
About the company:
• Manufactures radio & television antennas
• Last 5 years, doubled the number of products offered, expanded the production
facility twice & recently introduced the electronic antenna line.
• President Lincoln McDowell concerned about its ability to cost products accurately.
Glenn Peterzon, a management consultant’s observations about the company’s cost system:
• After computing the standard cost, selling price was calculated on the basis of
40% mark-on.
• Industry selling prices were different as they were established using the actual
production costs & a 40% mark-on.
• On comparing the industry prices to the firm’s costs profitability was determined.
• Because of this the resulting product mix differed from the starting mix which led
to recalculation of allocation rate per hour to determine if it had been affected.
Answers
Charges for 40% mark on and Product to be dropped
Variable
Product Labour Variable Total
Overhea Hours Per Overhead Labour
d Unit Per Unit No. Of Units Hours Total ($)
B 1 7.5 2000 2000 15000
C 3 5 1000 3000 5000
D 2 7.5 1000 2000 7500
Total 7000 27500
New
Alocatio
n Rate:
Variable
Overhea
d 27500
Fixed
Overhea
d 45000
Total 72500
Labour
Hours 7000
Allocatio
n
Rate/Ho
ur 10.36
Product B C D
Material 5 10 5
Labour 5 15 10
Allocate
d Cost 10.36 31.07 20.71
Standard
Cost 20.36 56.07 35.71
40%
Mark On 8.14 22.43 14.29
Selling
Price 28.50 78.50 50.00
Standard
Cost 27.5 42.5 35
Mark On 11 17 14
Standard
Selling
Price 38.5 59.5 49
Variable
Product Labour Variable Total
Overhea Hours Per Overhead Labour
d Unit Per Unit No. Of Units Hours Total ($)
B 1 7.5 3000 3000 22500
D 2 7.5 1000 2000 7500
Total 5000 30000
New
Alocatio
n Rate:
Variable
Overhea
d 30000
Fixed
Overhea
d 45000
Total 75000
Labour
Hours 5000
Allocatio
n
Rate/Ho
ur 15.00
Product B D
Material 5 5
Labour 5 10
Allocate
d Cost 15.00 30.00
Standard
Cost 25.00 45.00
40%
Mark On 10.00 18.00
Selling
Price 35.00 63.00
Standard
Cost 27.5 35
40%
Mark On 11 14
Standard
Selling
Price 38.5 49
Hence product D is to be
discontinued.
Camelback Communications is calculating the allocation rate by adding together all the fixed
and the variable cost for all the products together and then dividing them by the total labour
hours. Now this method of calculating the allocation rate is incorrect because
• Also, the variable overhead that is calculated in this method is not correct because the
variable overhead per unit is different for different products.
Hence we can see the variation between the industry selling prices and that given by the
costing system in place.
Because of wrong allocation of costs, we find that certain products are gaining because the
costs that should be truly attributed to them are being given to other products and vice versa.
Therefore the products whose costs are getting increased due to the wrong allocation are
showing less than desirable profits although there mark up is the same.
Eg.
The actual cost that should be attributed to A is $70, but due to the faulty cost system a cost
of $85 is getting attributed to it. Now the Selling price calculated based on the industry
standard remains the same and hence although the mark up is 40%, we seem to get a lower
mark up of 15% which leads to an equally profitable product being discontinued.
If fixed costs are allocated using the current costing system and variable costs
are correctly attributed then,
Variable
Product Labour Total
Overhea Hours Per Labour
d Unit No. Of Units Hours
A 6 1000 6000
B 1 2000 1000
C 3 1000 3000
D 2 1000 2000
Total 12000
New
Alocatio
n Rate:
Fixed
Overhea
d 45000
Labour
Hours 12000
Allocatio
n
Rate/Ho
ur 3.75
Product A B C D
Material 15 5 10 5
Labour 30 5 15 10
Variable
overhea
d 15 7.5 5 7.5
Allocate
d Cost 22.5 3.75 11.25 7.50
Standar
d Cost 82.5 21.25 41.25 30
40%
Mark On 33 8.5 16.5 12
Selling
Price 115.5 29.75 57.75 42
Standard
Cost 70 27.5 42.5 35
Mark On 28 11 17 14
Standar
d
Selling
Price 98 38.5 59.5 49
From the above, we can see that there is very little change in the balancing of
the costs of the product and even in this case product A would get discontinued.
Also, it is clearly evident from this that the wrong allocation of variable cost has
a much greater hand in the deviation of the costs from their true value as
compared to fixed costs.