TUTORIAL 4 – Full Costing II

Week 6

Question 1

Rodney plc is a manufacturer of ‘the Del’, a revolutionary product in the home

heating industry, among other home heating products.

Their budgeted costs for the financial year 2012 are as follows:

Production Service
Assembly Finishing Maintenance Total
£’000 £’000 £’000 £’000
Direct materials 700 450 0 1,150
Direct labour 350 675 0 1,025
Indirect materials 425 600 75 1,100
Indirect labour 300 250 25 575
General overheads 475 575 350 1,400
Rent 250

You also have the following information about the business:

Assembly Finishing Maintenance Total

Direct labour hours 350,000 500,000 - 850,000
Machine hours 800,000 600,000 150,000 1,550,000
Number of employees 25 31 9 65
Floor area (sqm) 21,000 25,000 14,000 60,000

Required:

a) Apportion the rent costs for Rodney plc to the three departments identified in
the table above, on an appropriate basis. State on which basis you have
apportioned the rent costs.
b) Apportion the total costs for the maintenance department (including the rent
cost apportioned in part a) to the production departments on an appropriate
basis. State on which basis you have apportioned these costs.
c) Using the information from parts (a) and (b), calculate the overhead recovery
rate for each production department based on direct labour hours.
d) If ‘the Del’ spends 2 hours in the assembly department and 3 hours in the
finishing department, what amount of overheads does ‘the Del’ absorb?

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 e) In what types of situations and for what decisions would businesses use full
costing information? Explain why full costing information is often considered
more useful than marginal costing in these situations.

Question 2

Psilis Ltd makes a product in two qualities, called “Basic” and “Super”. The business
is able to sell these products at a price that gives a standard profit mark-up of 25 per
cent of full cost. Management is concerned by the lack of profit.

Full cost for one unit of a product is calculated by charging overheads to each type of
product on the basis of direct labour hours. The costs are as follows:

Basic Super
£ £
Direct labour (all £10/hour) 40 60
Direct material 15 20

The total overheads are £1,000,000.

Based on experience over recent years, in the forthcoming year the business expects
to make and sell 40,000 Basics and 10,000 Supers.

Recently, the business’s management accountant has undertaken an exercise to try to

identify activities and cost drivers in an attempt to be able to deal with the overheads
on a more precise basis than had been possible before. This exercise has revealed the
following analysis of the annual overheads:

Cost Annual Number of activities

Activity and Cost Driver
£000 Total Basic Super
# of machine set-ups 280 100 20 80
# of quality-control inspections 220 2,000 500 1,500
# of sales orders processed 240 5,000 1,500 3,500
General production (machine hours) 260 500,000 350,000 150,000
Total 1,000

The management accountant explained the analysis of the £1,000,000 overheads as

follows:

 The two products are made in relatively small batches, so that the amount of
the finished product held in inventories is negligible. The Supers are made in
very small batches, because their demand is relatively low. Each time a new
batch is produced, the machines have to be reset by skilled staff. Resetting for
Basic production occurs about 20 times a year and for Supers about 80 times:
about 100 times in total. The cost of employing the machine-setting staff is

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 about £280,000 a year. It is clear that the more set-ups that occur, the higher
the total set-up costs; in other words, the number of set-ups is the factor that
drives set-up costs.
 All production has to be inspected for quality and this costs about £220,000 a
year. The higher specifications of the Supers mean that there is more chance
that there will be quality problems. Thus, the Supers are inspected in total
1,500 times annually, whereas the Basics only need about 500 inspections.
The number of inspections is the factor that drives these costs.
 Sales order processing (dealing with customers’ orders, from receiving the
original order to dispatching the products) costs about £240,000 a year.
Despite the larger amount of Basic production, there are only 1,500 sales
orders each year, because the Basics are sold to wholesalers in relatively large-
sized orders. The Supers are sold mainly direct to the public by mail order,
usually in very small-sized orders. It is believed that the number of orders
drives the costs of processing orders.

Required:

(a) Deduce the full cost of each of the two products on the basis used at present
and, from these, deduce the current selling price.
(b) Deduce the full cost of each product on an ABC basis, taking account of the
management accountant’s recent investigations.
(c) What conclusions do you draw? What advice would you offer the
management of the business?

Question 3 (to be completed as self-study after the tutorial)

Burton Ltd has been invited to tender for a contract to produce 1,000 clothes hangers.
The following information relates to the contract:
 Materials: The clothes hangers are made of metal wire covered with a padded
fabric. Each hanger requires 2 metres of wire and 0.5 square metres of fabric.
 Direct labour: - Skilled: 10 minutes per hanger
- Unskilled: 5 minutes per hanger

The business already holds sufficient of each of the materials required to complete the
contract. Information on the cost of the materials is as follows:

Metal wire Fabric

£ per metre £ per square metre
Historic cost 2.20 1.00
Current buying-in cost 2.50 1.10
Scrap value 1.70 0.40

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The metal wire is in constant use by the business for a range of its products. The
fabric has no other use for the business and is scheduled to be scrapped.
Unskilled labour, which is paid at the rate of £5.00 an hour, will need to be taken on
specifically to undertake the contract. The business is fairly quiet at the moment,
which means that a pool of skilled labour exists that will still be employed at full pay
of £7.50 an hour to do nothing if the contract does not proceed. The pool of skilled
labour is sufficient to complete the contract.
The business charges jobs with overheads on a direct labour hour basis. The
production overheads of the entire business for the month in which the contract will
be undertaken are estimated at £50,000. The estimated total direct labour hours that
will be worked are 12,500. The business tends not to alter the established overhead
recovery rate to reflect increases or reductions to estimated total hours arising from
new contracts. The total overhead cost is not expected to increase as a result of
undertaking the contract.
The business normally adds 12.5 per cent profit loading to the job cost to arrive at a
first estimate of the tender price.

Required:
(a) Price this job on a traditional job-costing basis (full costing).
(b) Indicate the minimum price at which the contract could be undertaken such
that the business would be neither better nor worse off as a result of doing it.