The Spare for Ships Company (SFS) has a specialist machining facility which serves the shipbuilding components market. The current job-costing system has two categories of direct cost (direct materials and direct manufacturing labour) and a single indirect cost pool (manufacturing overhead which is allocated on the basis of direct labour hours). The indirect cost allocation rate of the existing job-costing system is $120 per direct manufacturing labour-hour.
Recently, the Visibility Consultancy Partnership (VCP) proposed the use of an activity-based approach to redefi ne the job-costing system of SFS. VCP made a recommendation to retain the two direct cost categories. However, VCP further recommended the replacement of the single indirect-cost pool with fi ve indirect-cost pools.
Each of the fi ve indirect-cost pools represents an activity area at the manufacturing premises of SFS. Each activity area has its own supervisor who is responsible for his/her operating budget.
Relevant data are as follows:
SFS has recently invested in ‘state of the art’ IT systems which have the capability to automatically collate all of the data necessary for budgeting in each of the fi ve activity areas.
The management accountant of SFS calculated the manufacturing cost per unit of two representative jobs under the two costing systems as follows:
Required:
(a) (i) Compare the cost fi gures per unit for Job order 973 and Job order 974 calculated by the management accountant and explain the reasons for, and potential consequences of, the differences in the job cost estimates produced under the two costing systems; (8 marks)
(ii) Explain two potential problems that SFS might have experienced in the successful implementation of an activity-based costing system using its recently acquired ‘state of the art’ IT systems. (4 marks)
(b) ‘The application of Activity Based Management (ABM) requires that the management of SFS focus on each of the following:
(i) Operational ABM;
(ii) Strategic ABM;
(iii) The implicit value of an activity’.
Required:
Critically appraise the above statement and explain the risks attaching to the use of ABM. (8 marks)