EMBA International Accounting 2012/13 Abdelhak Tejjini Austen Cohort 12/11/2012 The Cylinder Manufacturing Company Part 1

We will start by categorizing the overhead activities into production and nonproduction activities. The production activities will consist of machines and materials handling whereas the non-production activities are composed of the setups and engineering. At The Cylinder Manufacturing Company we have the following activity cost pools and activity measures: Activity Cost Pools at the Cylinder Manufacturing Company Activity Cost Pool Production related Overhead activities: Machines Materials handling Number of store orders Activity Measure Number of direct labour hours

Non-production related Overhead activities: Setups & Engineering

Distribution of resource consumption across Activity cost pools:

Activity Cost Pools Production Non-production Activity Activity 100% 0% 100% 0% 0% 100%

Machines Materials Handling Setups & Engineering

Step1:
Budgeted overhead costs per month in non-production volume cost Set-up and engineering support production volume cost Machines Materials handling Total overhead Total Manufacturing cost excluding direct materials 20020 0 20020 0 39910 0 27950 0 11960 0 59930 0 76930 0

Step2:
Distribution of the cost pools: Activity Pool Non-production volume cost Production volume cost Total overhead cost Monthly cost in 200200 399100 599300 Measure of activity Number of store orders Number of direct labour hours

Step3:
Cost Non-production volume cost Product volume cost 200200 399100 Total Store orders 460 Total labour hours 4000 Cost 435.21739 13 99.775

Per order Per hour

Step4:
Overhead rate calculation Machine hours Setups & engineering cost 399100 200200 Machine hrs 6500 N setups 280 Rat e 61. 4 715

/hour /setu p

Step5:
Unit costs for the company: Different costs

Direct labour

Machine

Setups

Std product Spe product

68 113.33

overhead 214900 184200

overhead 57200 143000

Step6:
Non product volume cost (Standard product) Non product volume cost (Specialise d product) product volume cost (Standard product) Direct labour (Standa rd product ) Direct labour (Specialis ed product)

Category Activity rate multiplied by quantity of activity measure in() Total monthly cost in () Total unit cost in ()

product volume cost (Specialised product)

69635.2 27.84

130566 87.044

249437.5 99.775

149662.5 99.775

326952 50 13078.1

3269428 8 21796.19

Step7:
Stadard product Total cost in () 69634.782 61 249437.5 32695250 Total Unit cost in () 27.85391304 99.775 13078.1 Specilized product Total cost in () 130565.21 74 149662.5 32695250 Total Unit cost in () 87.04347826 99.775 21796.83333

NPVC PVC Direct labour

Total cost Total overhead cost Total direct labour cost

33014322. 28 319072.28 26 32695250

13205.72891 127.628913 13078.1

32975477. 72 280227.71 74 32695250

21983.65181 186.8184783 21796.83333

Part 2
According to the total cost calculation in step 6 the cost of producing the specialized product is 0.12% (100*(1-(33014322.28/32975477.72))) less than the cost of producing the standard product. Although the non-product volume unit cost for specialized product 87.044 is higher than the standard product 27.84, the latter produce only 160 orders

whereas the first produce 300 orders. Also It is to be highlighted that the specialized products involves 1500 labour hours to produce 300 orders whereas the standard product involves 2500 labour hours (1000 hours less). Furthermore the unit cost for machine overheads for the specialised product is 184200 which is less than unit cost of standard product, 214900. That means that the Cylinder Manufacturing Company could potentially improve its performance by 16.66% just by producing specialized product. Even if the setup overhead for specialized product is 2.5 times the standard product, the number of setups for the latter is nearly half the setups needed for the specialized products. In term of profit generation its worth mentioning that the specialized product will generate 353.50% more profit than the standard product. This will help offset the 66.46% increase in the total unit cost engaged in producing specialized product compared to the standard product.

Part 3:
Davina is puzzled because even if they are meeting their sales target the profits are falling. Thanks to the activity based calculation and analysis done in part 1 and 2, we can see that this was due to the fact that the Cylinder Manufacturing Company has suffered from the incorrect labour and machine hours cost allocation. Indeed, and despite the cost advantage offered by producing the standard product the margin profit of the latter is considerably less than the specialized product. Furthermore the cost incurred in producing the specialized product is less. The Cylinder Manufacturing Company could/should then: Producing more high margin specialized product as immediate step to retrieve the business profitability as highlighted in part 1 and 2 Tackle the high cost of producing the standard products thus increasing the profit on this product by implementing proper machine and labour hours such that the number of setups and number of store orders are increased accordingly

The budgeted overhead burden of 149.825/labour hour is higher the actual cost of producing the specialized product. Davina should improve the Companys operations performance.

If the Cylinder Manufacturing Company would spend slightly more in labour hour to produce standard product and engage in increasing its productivity and quality which will give them a competitive advantage and better value for the customer thus a higher profit margin

Tackling the blame culture within the company between the production and sales and marketing team by involving them in a hybrid cross functional team to implement and maintain the Activity Based Costing system