Question 1: Activity-based costing
East Coast Marine Ltd (ECM) manufactures parts for small marine craft. Over the past decade, ECM’s management has met its goal of reducing its reliance on government contract work to 50 per cent of total sales. ECM is now equally reliant on commercial sales and government contracts.
 Traditionally, the costs of the Material Handling Department have been  allocated to direct material as a percentage   of direct material dollar value. This was adequate when the majority of the manufacturing was homogeneous and  related to government contracts. Recently, however, government auditors have rejected some proposals, stating that  ‘the amount of Material Handling Department costs allocated to these proposals is disproportionate to the total effort involved’.
 Eloise Smith, the newly hired cost accounting manager, was asked by the manager of ECM’s Government Contracts Unit, Paul Jones, to find a more equitable method of allocating the Material Handling Department costs to the user departments. Her review has revealed the following information:
 The majority of the direct material purchases for government contracts are high-dollar, low-volume purchases, while commercial materials represent low- dollar, high-volume purchases.
1Calculate the material handling rate that would have been used by Eloise Smith’s predecessor at East Coast Marine.
2Calculate the revised material handling costs to be allocated on a per purchase order basis.
 
3Discuss why purchase orders might be a more reliable cost driver than the dollar amount of direct material.
4Calculate the difference due to the change to the new method of allocating material handling costs to government contracts.
5Prepare a forecast of the cumulative dollar impact over a three-year period (based on the coming year plus 2 more years) of Eloise Smith’s recommended change for allocating Material Handling Department costs to the Government Contracts Unit. Round all calculations to the nearest whole number.
6Referring to the standards of ethical conduct for accountants described in Chapter 1:
 
(a)Discuss why Eloise Smith has an ethical conflict.
(b)Identify several steps that Smith could take to resolve the ethical conflict.

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