Group Case Study: JC Co.
JC Co. assembles three types of kid’s scooter at the same factory: the 8-inch Myway; the 10-inch Speedway and the 12-inch ZoomAir. It sells the kid’s scooters throughout the world.
In response to market pressures JC Co. has invested heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the size of its workforce.
Historically, the company has allocated all overhead costs using total direct labour hours, but is now considering introducing Activity Based Costing (ABC). The accountant of JC Co. has produced the following analysis.
(units) Annual Direct Labour Hours Selling Price ($ per unit) Raw Material Cost ($ per unit)
Myway 2,000 20,000 140 40
Speedway 1,600 22,000 180 30
ZoomAir 400 8,000 220 52
The three cost drivers that generate overheads are:
Deliveries to retailers – the number of deliveries of scooters to retail showrooms
Set-ups – the number of times the assembly line process is re-set to accommodate a production run of a different type of scooter
Purchase orders – the number of purchase orders.
The annual cost driver volumes relating to each activity and for each type of scooter are as follows:
Number of deliveries to retailers Number of set-ups Number of purchase orders
Myway 100 35 400
Speedway 80 40 300
ZoomAir 70 25 100
The annual overhead costs relating to these activities are as follows:
Deliveries to retailers 24,000
Set-up costs 60,000
Purchase orders 36,000
All direct labour is paid at $5 per hour. The company holds no stocks.
At a board meeting there was some concern over the introduction of activity based costing.
The finance director argued: ‘I very much doubt whether selling the ZoomAir is viable but I am not convinced that activity based costing would tell us any more than the use of labour hours in assessing the viability of each product.’
The marketing director argued: ‘I am in the process of negotiating a major new contract with a scooter rental company for the Myway model. For such a big order they will not pay our normal prices but we need to at least cover our incremental costs. I am not convinced that activity based costing would achieve this as it merely averages costs for our entire production’.
The managing director argued: ‘I believe that activity based costing would be an improvement but it still has its problems. For instance if we carry out an activity many times surely we get better at it and costs fall rather than remain constant. Similarly, some costs are fixed and do not vary either with labour hours or any other cost driver.’
The chairman argued: ‘I cannot see the problem. The overall profit for the company is the same no matter which method of allocating overheads we use. It seems to make no difference to me.’
Imagine you are an external consultant and you are to write a Management Report (in approximately 1,500 words) to the management of JC Co. to assist them in decision making. Your report should:
• Have a table of contents, introduction, main body, & conclusion. (No executive summary is needed)