Question

Life Symphony Enterprises (LSE) produces health and beauty products with manufacturing and distribution facilities all over the UK. The company currently employs 1,000 employees with an annual turnover of £30m. Sally Mason is the Group Management Accountant of the firm and her primary role includes supporting other staff working in various divisions in making decisions on cost management; divisional performance evaluation and operational priorities. This week, she has received several queries from various offices. You, as a promising intern, has been appointed to assist her in various investigations. In your interview for this position, you had demonstrated your knowledge in various management accounting issues, for instance, cost classifications, behavioural analysis, cost reporting under marginal and variable costing, traditional costing system, Activity-based costing system and variance analysis. Sally is really looking forward to working with you and on your fifth day in the job, she has handed you email trails, notes and conversation with her colleagues. You have arranged all materials in order and found the following:

1. On 10^th February, 2020 John Beecroft from the group’s Hull Division sent her an email asking for some clarification on cost calculation. The division estimates overhead costs as £12 per machine hour. John observed that in the last few months, the estimated overhead costs could not predict the product cost well. John sent the following 8 occurrences as evidence:

Machine hours	Actual Overhead costs (£)
1,000	10,700
1,500	15,700
1,250	13,200
2,100	21,700
1,875	19,500
1,680	17,500
2,250	23,200
1,725	17,950

Sally’s note suggests that counting overheads as a variable cost probably cause the inaccurate estimates though she put several interrogative signs (???) suggesting further investigation.

Write an email/ note on behalf of Sally to John explaining the possible causes of distorted overhead cost per machine hour by exhibiting an application of any management accounting technique that may provide a better result.  

Answer 1

Requirement 2 Machine Hours Actual Overhead costs (£) Max 2,250 Min 1,000 machine hours giving negative fixed cost have not been considered 23,200 the costs at the highest level of activity, 10,700 the costs at the lowest level of activity High Low method takes two extreme activity levels (i.e. no of machine hours) from a set of actual data of various activity levels and their corresponding High-Low Method Formulas Variable cost per machine hour (b) is calculated using the following formula: Variable Cost per machine hour = (y2 - y1) /( x2-x1) Y2 is the total cost at highest level of activity; Y1 is the total cost at lowest level of activity; x2 are the number of machine hours at highest level of activity; and x1 are the number of machine hours. at lowest level of activity Variable Cost per machine hour(b) = (y2 - y1)/(x2-x1) 23,200 10,700 2,250 1,000 10.00 The variable cost per machine hour is equal to the slope of the cost volume line (i.e. change in total cost = change in number of machine hours produced) Total fixed cost (a) is calculated by subtracting total variable cost from total cost, thus: Total Fixed Cost (a) = y2 - bx2 = y1 – bx, 700.00 700.00 y = a + bx Y (Overhead costs)= $10x +$ 700 Where x is the number of machine hours required The overhead cost given above is in the nature of mixed cost which has component of both fixed and variable element hence, counting overheads only as a variable cost probably cause the inaccurate estimates. The high-low method is a management accounting technique used to split mixed costs into variable and fixed costs. The fixed component is £700 The variable cost is £10 per Machine hour Y (Overhead costs)= $10x +$700