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Question: Your company Nailscrew Ltd is a tool company that has been told by strategic management to conduct market analysis of prices to stay competitive as their number one rival has set up shops directly next to all Nailscrew outlets

19 Oct 2022,11:21 PM

 

Your company Nailscrew Ltd is a tool company that has been told by strategic management to conduct market analysis of prices to stay competitive as their number one rival has set up shops directly next to all Nailscrew outlets which has led to customers being incredibly price sensitive as they can simply walk next door for a comparison.

 

Nailscrew Ltd has two main distinct drills that are very popular.

 

  • The ‘Lightrange’ cordless drill that is used for less brittle services
  • The ‘Hardcore’ drill that can be used on any surface

 

While Nailscrew Ltd currently uses traditional absorption costing, see ‘currently used: traditional analysis’, the financial director has recently gone to a seminar on Activity Based Costing and has produced a more in-depth analysis of the overhead costs within Nailscrew Ltd (see appendix 1). The financial director believes this information should be used to re analysis the cost per unit and selling price of the two drills.

 

Overheads

Production overheads are £5,700,000 and traditionally have been absorbed on the basis of labour hours.

 

Currently Used: Traditional Analysis

 

 

Lightrange

Hardcore

labour time per unit

0.5 hour

0.75 hour

Sales/Production

300,000 units

200,000 units

Overhead per unit (£19 per labour hour)

 

£9.50

 

£14.25

Current sales price

£35

£65

 

Activity Based Costing Analysis (appendix 1)

 

  1. Cost driver Information

 

 

£

Cost Drivers

Lightrange

Hardcore

Machining costs

2,050,000

Machine hours

 

0.25 hour

 

0.5 hour

Set up costs

1,900,000

Time taken for set-up (hours)

 

5,000

 

40,000

Inspection costs

1,750,000

Number of inspections

 

1,000

 

2,000

Total overhead

5,700,000

 

 

 

 

 

 
  1. Overhead per Activity:

Machine cost per hour £2,050,000/ 175,000 hours = £11.71 per machine hour Set up costs per hour £1,900,000/45,000 hours = £42.22 per set up hour Inspection costs per inspection £1,750,000/3,000 inspections = £583.33 per inspection

 

 

Lightrange

Hardcore

Machining costs

75,000 x £11.71 =878,250

100,000x £11.71 =1,171,000

Setup costs

5,000 x £42.22 =211,100

40,000 x £42.22= 1,688,800

Inspection costs

1,000 x £583.33 =583,330

2,000x £583.33 =1,166,660

Total overhead

£1,672,680

£4,026,460

Number of units

300,000 units

200,000 units

Overhead cost per unit (using ABC)

 

£5.58 per unit

 

£20.13 per unit

 

Required:

You are the management accountant at Nailscrew Ltd. The senior management accountant Ruby Ng, who is your line manager, has reviewed the work from the financial director. Ruby sends you the following email which she is expecting a response too.

 

EMAIL

To: Management Accountant (you)

Subject: Activity Based Costing Analysis within Nailscrew

 

Dear Management Accountant,

I hope you are well and coping working from home. I am writing in hope that you can help me with some information forwarded me from the financial director. Additionally, I have a few questions in regards other areas of our work. These requirements I have numbered below and need you to address them in a responding email please:

 

  1. Explain, using specifically appendix 1 section a and b, how the analysis for ABC was created for the two drills.

Generic explanations are not useful, so I need you to refer to the numbers and how they were calculated specifically for appendix 1a and 1b information.

 

  1. Can you explain why there is difference in overhead absorption rate per unit from the traditional analysis versus the ABC analysis (£3.92 for Lightrange: £5.88 for Hardcore). Include in your explanation implications to our business in regards the drill prices?
 
  1. Quickly could you explain if we changed only selling price of the two drills, as suggested in your part 2 above, how would this affect breakeven units of both drills. Assume that variable costs per drill and total fixed costs stayed the same.

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