uestion1 AirCom Corporation has a machining facility special

uestion1 AirCom Corporation has a machining facility specializing in work for the aircraft components market. The prior job-costing system had two direct-cost categories (diredct materials and direct labor) and a single indirect-cost pool (manufacturing overhead, allocated using direct labor hours). The indirect-cost allocation rate for the year amounted to RM115 per direct labor hour Recently, the management is considering implementing a general policy to discontinue any job whose gross profit margin percentage below 10 percent. In order to implement this, the management believes that accurate cost allocation is very important. Therefore, a team with members from product design, manufacturing and accounting has been asked to develop an activity based approach to refine the company\'s job-costing. The team has proposed the following five cost pool, each with its own supervisor and budget responsibility: Cost driver used asCost driver Activity areao Materials handlin Lathe work Millin Grindin Testin allocation base Parts Turns Machine hours Parts Units rate- RM0.40 RM0.20 RM20.00 RM0.80 RM15.00 Two representative jobs processed under the new system at the facility in the most recent period has the following characteristics: Job 454 Job 455 RM59,900 RM750RMI11,250 375 hours 2,000 parts 20,000 turns60,000 turns 1,050 hours 200 units RM9,700 Direct materials cost Direct labor cost per job Direct labor hours per job Parts per job Turns per Machine hours Units 25 hours 500 parts 150 hours 10 units ob

Solution

(b)

Gros margin for Job 454 has reduced from 30% to 4% whereas the gross margin for Job455 has increased from 12% to 16%.

This is due to the wrong allocation of the overhead based on direct labor hours which is very small in case of Job454 as the number of units is only 10 whereas for Job455 the number of units is 375. Naturally the allocation of overheads to Job454 will be very less as compared to Job455.

Since the overhead allocation under the activity based costing is dependent on the different activities involved and the respective cost drivers , the cost allocaion will be much closer to the actual share for the jobs.

Since the job454 is generating a gross margin percentage of only 4% , the company is well advised to discountinue the product unless there is a scope for reducing the cost in other areas.

(c)

The production manager Don is not acting ethically. The management should be informed of the actual situation and there should not be any adjustments to the figures arrived at.

Instead Alan should try to reason with Don about the new system explaining the situation with the help of the figures and convince him about the usefulness of the activity based system for the performance on the compnay.

(a) (i) Prior job-costing sustem.
	Job 454	Job455
Direct labor hours	25	375
Direct materials	9700	59900
Direct labor	750	11250
Manufacturing overhead	2875	43125
(@ RM115 per direct labor hour)
Total cost for the job	13325	114275
Units per job	10	200
Cost per unit	1332.50	571.38
(a) (i) Prior job-costing sustem.
	Job 454	Job455
Direct labor hours	25	375
Direct materials	9700	59900
Direct labor	750	11250
Manufacturing overhead *	7750	38400
Total cost for the job	18200	109550
Units per job	10	200
Cost per unit	1820.00	547.75
Overhead allocation based on activity based system.
			Job 454	Job 455
Activity area	Cost driver	Cost driver	Cost driver	Cost	Cost driver	Cost
		rate	units	Allocated	units	Allocated
Material handling	Parts	0.40	500	200	2000	800
Lathe work	Turns	0.20	20000	4000	60000	12000
Milling	Machine hours	20.00	150	3000	1050	21000
Grinding	Parts	0.80	500	400	2000	1600
Testing	Units	15.00	10	150	200	3000
Manufacturing overhead allocated *				7750		38400