Question

Rainbow Company produces two types of monitors – regular and multifunction. The company has produced the regular monitor for years whereas the multifunction monitor was introduced in the year 2016 to exploit the military vessels market. However, since the introduction of the new monitor, the company’s profitability has not increased as expected. Therefore, the management has particularly focused its attention on the company’s costing method. The existing costing method allocates the company’s production support costs to the two products on the basis of direct labour hours. The company has estimated that it will incur Kr 2 400 000 worth production support costs and will produce 100 multifunction monitors and 1 000 regular monitors. Whilst a regular monitor requires 5 direct labour hours, a multifunction monitor requires 10 direct labour hours. Material and labour costs per unit and selling price per unit are as follows:

Item Regular Multifunction

Direct material cost (Kr) 4 000 5 000

Direct labour cost (Kr)    2 000 6 000

Selling price (Kr) 10 000 20 000

The management has decided to trace its production support costs to four activities. The production support costs are traceable to the four activities are as follows:

Activity Cost Driver Cost (Kr)

Purchasing orders Number of orders 200 000

Quality control Number of inspections 700 000

Product setups   Number of setups    800 000

Machine maintenance Machine hours 700 000

The cost drivers with respect to the two products are as follows:

                       

Cost Driver Regular   Multifunction

Number of purchasing orders 40 10

Number of quality inspections 50 20

Number of production setups 100 100

Machine maintenance hours 300 400   

    

1. Estimate the production cost per unit and profitability of the two products using the traditional costing method and ABC method.

1. Explain the management why the company’s profitability has not increased as expected.

Answer 1