Question

Case study Sothern Digital Sdn. Bhd. produces three types of circuit board at the same factory: the Gold circuit; the Platinum circuit and the Silver circuit. The company started as a producer of circuit boards for a basic laptop. However, due to its competitors grew larger, Southern Digital had to find niche market where its small size would not hinder its ability to compete. In November 2018, Southern Digital managed to sign a contract with Tech World Sdn. Bhd. (TWSB) to supply the three circuit boards for a laptop for use in dangerous environments. TWSB’s main customers are organizations like oil and gas companies and the military that require a laptop rough handling in transport to a site and can be made to their unique requirements. Southern Digital is now considered as the one of the best circuit boards producer in this sector. These two companies have a 3-year mutual contract in which Southern Digital become the major supplier of Gold circuit board, Platinum circuit board and Silver circuit board to TWSB. Annually, Southern Digital produces and sells 15,000 units of Gold circuit board, 12,000 units of Platinum circuit board, and 18,000 units of Silver circuit board to TWSB. They are expected to ink the renewal contract in November 2020. However, recent tension in business environment due to the pandemic outbreaks, a new chief executive officer (CEO), Mr. Andrew, has been appointed to avoid any fall in profitability for each product. Mr. Andrew immediately held a meeting with his top management team. The atmosphere in the meeting was filled with apprehension. Mr. Andrew mentioned in the meeting: “For the first step, I want to review this company’s financial and costing systems in order to get better information with which to tackle the profit issue. I am thinking about pricing of the circuit boards to ensure that selling products at the wrong price is not compromising the profit margins. In current economic issues, the decline in profit is not sustainable. I am considering to adopt activity-based costing (ABC).” Mr. Andrew, CEO, Southern Digital “My simple calculation in my hand now shows that we need to consider stop supplying Silver circuit board. We cannot afford to sell the board below its selling price because it leads to major reduction in company’s profitability. By dropping the Silver circuit board, we can focus on the other two profitable products.” Mr. Siva, Plant Manager, Southern Digital 12 “I agree with Mr. Siva. We are in the process of negotiating the renewal contract soon. For such a big order, TWSB will not pay our selling prices if we offered them the new prices. I am not convinced that ABC would help us to tackle the profit issues as it merely averages costs for our entire production.” Mr. Edward, Marketing Manager, Southern Digital “Southern Digital Sdn Bhd. currently measures profitability for each circuit board using a traditional absorption costing system. All overhead costs are charged to the three circuit boards using direct labour hours as the basis for allocation. I cannot see the problem. The overall profit for the company is the same no matter which method we use. It seems to make no difference to me.” Mr. Lee, Finance Manager, Southern Digital The accountant, Mr. Tarmizi believes that before the management group proceeds with the discussion about discontinue supplying Silver circuit board to TWSB, it might be worthwhile to look at the company’s costing system. Tarmizi explained to the management group, “Activity-based costing (ABC) integrates the cost of all activities, known as cost drivers, into individual product costs rather than including these costs in the overhead pool. We can calculate an activity-based cost for each board and then compare it to the traditional absorption costing system we have been using.” Mr. Tarmizi, Management Accountant, Southern Digital The CEO asked him to immediately form an ABC taskforce to help the top management to make sound decisions before the renewal contract day comes. After analyzing the manufacturing activities and costs for Southern Digital, the information for the three products is as follows: Gold Platinum Silver Selling price per unit RM7.00 RM12.00 RM13.00 Direct material usage (kg) per unit 2kg 3kg 4kg Direct labour hours per unit 0.1 0.15 0.2 The price for direct materials remains constant throughout the year at RM1.20 per kg. Similarly, the direct labour cost for the whole workforce is RM14.80 per hour. The annual overhead costs are as follows: Activity cost pool Overhead cost (RM) Machine set-up costs 26,550 Production run 66,400 Procurement costs 48,000 Delivery costs 54,320 The study by the taskforce revealed the following information pertaining to cost drivers and marketing cost: 13 a) The machine setup overhead was generated by charging the job to be run and should be related to the number of machine setup. b) The people in the production department, process, inspect and move each batch of components for a production run. This work required the same amount of time regardless of whether the production run was long or short. Thus, the appropriate cost driver should be production hours per unit. c) The procurement overhead costs arise from number of purchase orders. The higher the number of purchase orders, the higher the procurement overhead costs. The appropriate cost driver should be the number of purchase orders. d) The delivery costs have nothing to do with direct labour-hours. These costs are more likely to vary with the number of deliveries per annum. The taskforce gathered the following information about the cost driver volume for each product: Activity cost driver Gold Platinum Silver Number of machine set-up 16 12 8 Production hours per unit 0.5 0.7 0.9 Number of purchase orders 24 28 42 Number of deliveries per annum 48 30 62 You are working in Southern Digital Sdn. Bhd. during your internship and you are part of the taskforce. You are required to prepare a business report on behalf of the taskforce. The intention of the business report is to provide Mr. Tarmizi with a better understanding of the situation in the company. The business report would need to cover the information listed in the next page. 14 Required Part A: Calculation (show detailed workings) 1. Calculate the product cost per unit for Gold circuit board, Platinum circuit board and Silver circuit board under traditional absorption costing. 2. Calculate the product cost per unit for Gold circuit board, Platinum circuit board and Silver circuit board using ABC. Part B: Analytical Discussion For this part, please refer to your calculations in part A above where appropriate. 1. Compare the costs of each board in requirement 1 and 2. Why do the current costing system and activity-based costing systems differ in the cost of the Gold board and Platinum board? 2. Compare the profits of each board. What are the least profitable and most profitable products under traditional absorption costing? Using ABC, is Gold as profitable as the company thinks it is under the current costing system? Briefly comment on your answer. 3. Describe the limitations of the company’s current traditional costing system. 4. Explain how activity-based costing may help Southern Digital Sdn. Bhd. improve the profitability of each product. 5. Activity-based costing seems to provide the company with the most accurate cost information. Provide a detail explanation regarding the limitations in implementing activity-based costing system. 6. Please comment on the issue raised by the Plant Manager on discontinue supplying Silver circuit board. Specifically comment on the pricing and product mix decisions. Part C: Written communication analysis Please refer to the marking rubric for allocation of marks.

Answer 1

1. the product cost per unit for Gold circuit board, Platinum circuit board and Silver circuit board under traditional absorption costing:-

part A:-

1) under absorption costing, product cost per unit = direct cost per unit + indirect cost per unit

i)calculating cost of gold circuit board per unit using absorption costing:

DM+DL+OH = (1.2x2)+(0.1x14.8)+(26550+66400+48000+54320)/45000

= 2.4+ 1.48+ 4.33= 8.21

ii) calculating cost of platinum circuit board per unit using absorption costing:

DM+DL+OH =( 3x1.2)+(0.15x14.8)+4.33 = 3.6+2.22+4.33 = 10.15

iii) calculating cost of silver circuit board per unit using absorption costing:

DM+DL+OH = (4x1.2)+(0.2x14.8)+4.33 = 4.8+2.96+4.33 = 12.09

2) the product cost per unit for Gold circuit board, Platinum circuit board and Silver circuit board using ABC.

OH allocation table using ABC:

Circuit type	No.of machine setup	% of total/100	Machine setup cost allocated	Production hrs per unit	% total/100	Production run cost allocated	No.of purchase order	% of total/100	Procurement cost allocated	No.of deliveries per annum	% of total/100	Delivery cost allocated
Gold	16	0.44	7.04	0.5	0.24	0.12	24	0.26	6.24	48	0.34	16.32
Platinum	12	0.33	3.96	0.7	0.33	0.231	28	0.29	8.12	30	0.21	6.3
Silver	8	0.22	1.76	0.9	0.43	0.387	42	0.45	18.9	62	0.44	27.28
	36			2.1			94			140

note: % of total is calculated by dividing individual value by total of that column.

OH cost is then allocated by multiplying the value in "% of total/100" column with individual value.

i)product cost per unit for gold circuit board using ABC = DM +DL+OH

= 2.4+ 1.48+ (7.04+0.12+6.24+16.32) = 33.6

ii)product cost per unit for platinum circuit board using ABC = DM +DL+OH

= 3.6+2.22+(3.96+0.231+8.12+6.3) = 24.43

iii)product cost per unit for silver circuit board using ABC = DM +DL+OH

= 4.8+2.96+ (1.76++0.387+18.9+27.28) = 56.09

PART B

1) cost of overheads using ABC costing is more than cost of OH using absorption costing because in ABC, cost is allocated using activity based cost driver for each activity whereas in absorption costing a single value for overhead per unit is obtained by dividing total OH rate by total number of units. therefore we can say that cost of gold and platinum boards are more under ABC costing.

2) profits of each board using absorption costing:

gold: profit = selling price- cost per unit = 7-8.21 = -1.21 per unit

platinum : profit = 12-10.15 = 1.85 per unit

silver: profit = 13-12.09 = 0.91 per unit

the least profitable board under traditional absorption costing is gold circuit board (it gives a loss of 1.21 per unit) and the most profitable board is platinum circuit boaRD.

gold circuit is not profitable under current costing system as it gives a loss of 1.21 per unit.