Reference no: EM132501143

Point 1: House Extensions plc (HEP) manufactures three different lines of pre-fabricated conservatories (Victorian, Edwardian, and P-Shaped). The 2008 financial crisis caused the demand to drop. Although the economy is still fragile there is now more optimism especially within the construction industry, housing market and consumer spending. A potential problem, however, is a rise in interest rates by the end of 2015, which could lead to banks being less willing to lend money. This has left the overall market with a prediction of modest growth in the medium term (Home Extension Market Report GB 2014-2018). HEP knows that being cost efficient would provide the organisation with a competitive advantage.

Point 2: David Smith who is the management accountant at HEP has recently attended a course on Activity Based Costing (ABC). He is concerned that the current approach to overhead allocation adopted by the company, using machine hours as the sole cost driver, may be misrepresenting the real costs of production. He has decided to prepare a ABC analysis of product costs for the company's directors, and to make some recommendations based on his findings.

In order to start his analysis David gathered the following information:

1. The three products are each produced in batches of 10 units per production run.
2. 10 materials requisitions were processed by the Stores department for each product line. 
3. Products are sold in batches of 4 units, and a total of 100 deliveries were carried out.
4. Production data for December 2015 is as follows:

Product                                     Victorian                  Edwardian               P-Shaped

Output (units)                           100                       200                 100

Machine hours per unit                    6                      5                        4

Direct materials per unit (£)                 50                  30                   40

Direct labour per unit (£)                        20                   20                20

Overheads are currently allocated to products on the basis of machine hours, and an analysis of overhead expenditure is depicted below:

£

Machine set-up costs               6,000

Stores department costs            5,500

Delivery costs                           5,000

Machinery depreciation                  3,500

Total overheads                            20,000

Question 1: Is there any reason for David Smith to be concerned of the current cost approach?

Required:

Question a) Calculate the total cost per unit of each product as reported by the existing costing system, allocating overheads on the basis of machine hours;

Question b) Calculate the total cost per unit of each product using an ABC approach. You should use your judgement to choose suitable cost drivers, based on the information provided in the question;

Question c) Explain any differences in the unit costs reported under the two approaches

Question d) Explain how the use of internal and external information could help directors of House Extensions plc on decisions about future production, pricing and marketing strategy for their products.