Surtees plc assembles three types of jet ski at the same factory: the ‘Rapid’; the ‘Swift’ and
the ‘Thunder’. It sells the jet skis throughout the world. In response to market pressures
Surtees plc 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). Surtees plc’s accountant has
produced the following analysis:
Annual output
(units)
Annual direct
labour hours
Selling price
(£ per unit)
Raw material
Cost
(£ per unit)
Rapid 2,000 200,000 4,000 400
Swift 1,600 220,000 6,000 600
Thunder 400 80,000 8,000 900
The three cost drivers that generate overheads are:
Deliveries to retailers – the number of deliveries of jet skis 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 jet ski.
Purchase orders – the number of purchase orders
The annual cost driver volumes relating to each activity and for each type of jet ski are as
follows:
Number of deliveries
to retailers
Number of set-ups Number of purchase
orders
Rapid 100 35 400
Swift 80 40 300
Thunder 70 25 100
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The annual overhead costs relating to these activities are as follows:
Deliveries to retailers £2,400,000
Set-up costs £6,000,000
Purchase orders £3,600,000
All direct labour is paid at £5 per hour. The company holds no inventories.
Required:
(a) Calculate the total profit on each of Surtees plc’s three types of product
using traditional absorption costing, using direct labour hours as the basis
for apportionment. (5 marks)
(b) Calculate the total profit on each of Surtees plc’s three types of product
using activity based costing as the basis for apportionment. (10 marks)
(c) Using your calculations from (a) and (b) above, explain the difference in
total profit per product between the two overhead apportionment
methods. (6 marks)
(d) A non-executive director of Surtees plc has suggested that allocating
overheads to their products is pointless because the overall profit for the
company will remain the same no matter which method of allocating
overheads is used. She has instead suggested that a marginal costing
approach is adopted and fixed costs simply written off as a period cost.
Discuss this view and give your own conclusion, explaining your reasons
and the related ethical issues.
(9 marks)