Sunshine Co Ltd produces two types of window frame, aluminium and wooden. The company’s simple costing system has two direct cost categories (materials and labour) and one indirect cost pool. The simple costing system allocates indirect costs on the basis of machine hours. Recently, the owners of Sunshine have been concerned about a decline in the market share for aluminium, usually their biggest seller. Information related to Sunshine’s production for the most recent year follows:
Aluminium Wooden
Units sold 3,200 1,800
Selling price $125 $200
Direct material cost per unit $30 $45
Direct manufacturing labor cost per hour $16 $16
Direct manufacturing labour hours per unit 1.50 2.25
Production runs 40 85
Material moves 72 168
Machine setups 45 155
Machine hours 5,500 4,500
Number of inspections 250 150
The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect cost pool for Sunshine, six activities were identified as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, and marketing. Sunshine collected the following data related to the indirect cost activities:
Activity Activity Cost Activity Cost Driver
Production scheduling $95,000 Production runs
Material handling $45,000 Material moves
Machine setup $25,000 Machine setups
Assembly $60,000 Machine hours
Inspection $8,000 Number of inspections
Marketing costs were determined to be 3% of the sales revenue for each type of window.
Required:
a) Calculate the cost of an aluminium window frame and a wooden window frame under the existing simple costing system.
b) Calculate the cost of an aluminium window frame and a wooden window frame under an activity-based costing system.
c) Compare the costs of the window frame in requirements (a) and (b). Explain why the simple and activity-based costing systems differ in the cost of an aluminium window frame and a wooden window frame.
d) Advise how Sunshine Co. Ltd might use the new cost information from its activity-based costing system to address the declining market share for interior doors.