Why Is The Overseas Buyer Only Interested In Buying The Advance Sewing Machine Model?

Business information for the year 2017

Solution 1:

Statement of Cost- Traditional Approach
Particulars	Basic Model	Advance Model Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Units produced and sold	1,600	1,500
Direct Material cost per unit	325	560
Direct Labour cost per unit	150	260
Total Material Cost	5,20,000	8,40,000
Total Labour cost	2,40,000	3,90,000
Total Allocated Overhead cost	1,43,750	1,06,250
Other Operating Expenses for Advance model
– Selling and Administration expenses	–	1,40,600
– Interest Expense	–	25,200
– Office Rent	–	35,900
Total Cost	9,03,750	15,37,950
Cost Price Per unit	565	1,025

Allocation of Overhead-Traditional approach
Particulars	Amount
Inspection	20,000
Assembly	90,000
Production Scheduling	1,05,000
Machine set-up	35,000
Total Overhead to be allocated	2,50,000
Total Machine Hours consumed	8,000
Overhead per Machine Hour	31
– Overhead Allocated to Basic Model	1,43,750
– Overhead Allocated to Advance Model	1,06,250

 Solution 2:

Statement of Cost- ABC approach
Particulars	Basic Model	Advance Model
Units produced and sold	1,600	1,500
Direct Material cost per unit	325	560
Direct Labour cost per unit	150	260
Total Material Cost	5,20,000	8,40,000
Total Labour cost	2,40,000	3,90,000
Total Allocated Overhead cost	75,506	1,74,494
Other Operating Expenses for Advance model
– Selling and Administration expenses	–	1,40,600
– Interest Expense	–	25,200
– Office Rent	–	35,900
Total Cost	8,35,506	16,06,194
Cost Price Per unit	522	1,071

Allocation of Overhead-ABC Approach
Particulars	Inspection	Assembly	Production Scheduling	Machine set-up	Total Cost
Cost	20,000	90,000	1,05,000	35,000	2,50,000
Units	950	8,000	550	350
Cost per unit	21	11	191	100
Units for Basic Model	200	4,600	50	100
Units for Advance Model	750	3,400	500	250
Total Overhead for Basic Model	4,211	51,750	9,545	10,000	75,506
Total Overhead for Advance Model	15,789	38,250	95,455	25,000	1,74,494

 Solution 3:

Statement of Profit and Loss- Tradition Approach
Particulars	Basic Model	Advance Model
Sales	10,84,500	18,45,540
Less:
Total Material Cost	5,20,000	8,40,000
Total Labour cost	2,40,000	3,90,000
Total Allocated Overhead cost	1,43,750	1,06,250
Other Operating Expenses for Advance model
– Selling and Administration expenses	–	1,40,600
– Interest Expense	–	25,200
– Office Rent	–	35,900
Profit	1,80,750	3,07,590
Calculation of Sales Price Per unit- Tradition Approach
Particulars	Basic Model	Advance Model
Cost per unit	565	1,025
Add: profit margin 20%	113	205
Sale Price Per unit	678	1,230
Statement of Profit and Loss- ABC Approach
Particulars	Basic Model	Advance Model
Sales	10,02,607	19,27,433
Less:
Total Material Cost	5,20,000	8,40,000
Total Labour cost	2,40,000	3,90,000
Total Allocated Overhead cost	75,506	1,74,494
Other Operating Expenses for Advance model
– Selling and Administration expenses	–	1,40,600
– Interest Expense	–	25,200
– Office Rent	–	35,900
Profit	1,67,101	3,21,239
Calculation of Sales Price Per unit- ABC Approach
Particulars	Basic Model	Advance Model
Cost per unit	522	1,071
Add: profit margin 20%	104	214
Sale Price Per unit	627	1,285

 In the given case we see that the company Sewing Easy Ltd has an opportunity to sell one of its products to an overseas buyer. This buyer is only interested in buying the advance model manufactured by the company. The management is interested in knowing the reason behind the  interest of the overseas buyer only in the advance model. In order to understand, we have calculated the price and cost of the product under both traditional and activity based costing method.

The following tables show the price and cost of both the products under traditional and activity based costing:

Cost and Sales Price- Tradition Approach
Particulars	Basic Model	Advance Model
Cost per unit	565	1,025
Sale Price Per unit	678	1,230

Cost and Sales Price- ABC Approach
Particulars	Basic Model	Advance Model
Cost per unit	522	1,071
Sale Price Per unit	627	1,285

 From the above table we see that the currently the cost price of the advance model which is charged is $1025 per unit. This is under traditional costing system. If the company adopts the activity based costing then the cost allocated by the company will be $1071 per unit. The company has the policy of charging 20 percent margin on the cost price. Since the cost price of the advance model is lower under current costing system, the sales price charged from customer is also lower. The company has offered to sell the advance model to the overseas buyer at $1230. If the company had been using proper costing methods, the sales price charged would have been $1285.

Due to use of only one cost driver under traditional system of costing, the overheads are distributed in an absurd manner. Activity based costing allocates the cost among the products on the actual consumption of activity (Atkinson, 2012). This is more appropriate and helps to determine the correct cost of the product. Since the company has charged lower sales price from the customer, than the other companies in the market, the overseas buyer is interested in buying only the advance model. Due to shift of burden of expense of advance model to basic model, the price charged by the company for basic model is higher relative to other companies. This is why the overseas buyer is only interested in buying the advance model form the company and not the basic model.

Solution 4:

There are a few method of cost allocation. Under the absorption costing method, a pre determined rates is established, which is then used to ascertain the cost of the product. The company charges a margin on this cost and then decides its selling price (Berry, 2009). It is not necessary that the company would incur the same amount of expense as it has allocated while determining the selling price. There are variances in the amount charged from the customers and actual amount incurred. These differences create credit or debit position in the books and are to be treated.

Traditional costing system

Let us take an example in order to understand the concept of recovery of overheads. Suppose the company estimates that the overhead expense which is likely to incur are $5000, when 1000 units are expected to be produced. So taking this information the company determines the overhead rate to be $5 per unit (5000/1000). So when charging the sales price from the customer the company would have charged $5 for overheads. This was on estimated basis. The actual production done by the company was for 900 units and total overheads incurred was $3600, therefore, per unit overhead actually incurred was $4. The company sold 900 units and recovered $4500 (900*5). Therefore we see that the company has over allocated the overhead rate and also collected more amount than it was actually incurred. The over-recovery in the given case amounts to $900 (4500-3600). The company needs to adjust this amount in the books.

The only case when the applied and actual overheads can be same is the case when the company charges the overhead which has actually been incurred. Only in such a case can there be no under or over recovery. The company can treat the less and more recovered amount in the books in various ways. They are listed below:

• Charging the difference between the actual and applied overhead to the profit and loss statement. This is the easiest and most adopted methods of adjustment. Under this system the difference is simply charged to the profit and loss accounts and adjusted with the profit of the same accounting year.(Boyd, 2013)
• Carrying forward the amount of difference in the next accounting year. This method is also widely used by the manufacturers. Under this system the amount of difference is carried forward to the next accounting year. The manufactured then makes adjustment in the price of the product in order to eliminate the difference.
• Making the adjustment in the price of the product in the same accounting ear. Under this system, the company starts by selling the product at predetermined rate. After the Company calculates the difference in the overheads, it tries to adjust the amount amongst the remaining units unsold. This method is adopted only in cases where the difference is of considerable amount or any error has been made in estimating the overhead rate.(Datar M. S., 2015)

Therefore, we see that company can have situations of under or over recovery of overheads. Also, it has a few methods on how to treat these expenses in the books of accounts.

Solution 5:

The process of using the Activity Based Costing system is a type of technique which used to allocate the costs and expenses of different products on the basis of the resources that are being utilized by them in the process of manufacturing (Datar S. , 2016). The activity based costing system in a newly implemented technique which is helpful for a firm to allocate its cost and expenses incurred during the production process and thus make appropriate decisions.

This type of costing methods is proved to be very reliable in order to construct a relationship between the costs and the product. There are also problem faced during the allocation of few types of the costs which are present in the manufacturing process because of the diverse nature of the function like the administrative expenses. It have been constantly noticed that the cost of the manufacturing industries are much easier to allocate thus making this type of costing process much suitable for the production industries.

The main advantages that can be achieved by the use of the activity based costing method are:

1. Accurate production cost analysis: It has been made clear that the main function of the activity based costing method is to allocate the different costs in a group by differentiating in the services, actual and real cost of the product and thus estimate the price of the product. There are few industries in which the expenses of the firm are raised because of the small and various overhead expenses that constitute a huge past of the cosy of the manufactured product. Therefore it is very necessary for the firm to allocate the costs in a specified and elaborated manner so that there may be no problems faced in the future which will generate problems during the analysis of the cost of the products. (Horngren, 2012)
2. Assistance in controlling costs: the system of the performance of the activity based costing method clearly depends on the functional relationship present between the activities and the product, which makes it very accessible for the managers to determine the overhead expenses which are being incurred to a relation to the activity. There are many of the available measures that can be used by the firm in order to have a proper control over these types of costs. 
3. Helpful in discovering the activities: The method of the activity based costing consists of the assessment of the data of the application of each activity so that there can be a proper analysis made on the cost and then it can be allocated. This proves to be helpful to the manager in allocation of the activities that are not even related directly to the factory. This process thus ensures that there is no cost left uncovered during the valuation of the specific product.(Menifield, 2014)
4. Enhancing the decision making process: the data that have been collected by the use of the activity based costing method have proved to be reliable to the managers for the process of making further decisions on the activities carried out by the firm. This thus helps to provide a realistic price of the product that can be used by the firm to sell the product and thus helping it to control the costs as mentioned in the data provided above.
5. Helpful in the capacity realisation: The activity based costing method has been using the allocation process to determine the different group of activities and costs of production. This proves to be a herd for the managers in the assessment of the cost behaviour and also deciding that how can the maximum utilisation of the expenses incurred can be controlled. Thus the managers can find the particular methods that may help them to control the costs and thus put to application the unused capacity.

The above mentioned advantages were only one of the few most reliable objectives of the activity based costing method. Even after all the advantages the firm also faces some of the limitations while using such techniques which are clearly stated below:

1. Expensive and tortuous method for application: This type of costing system requires collection of the data at a single place so that it can be allocated in a proper manner. The process of collection of the data and the assessment of the usage is very complex and tiring which makes it unsuitable for the application in the costing process. (White, 2009)
2. Unsuitable for the small enterprises: the activity based costing consists of a lot of work that are needed to be done manually and thus making the process of the collection of data much costly for the small enterprises. Thus the application of the process is impractical in the smaller organisations.
3. Difficult to measure: The method makes the valuation of the expenses a lot better but it lacks in the determination of the consumption of resources by the products. This is a very complex work and thus need huge attention as any incorrect data presentation will lead to bad effects on the business.
4. Not very suitable for the service industry: It have been clearly mentioned above that appropriation of the costs is not an easy task. Also the service industry does not contain any unit, division of costs and utilities among them which makes the work very difficult. Therefore making the use of the activity based costing sterile in the services industry.

Therefore it have been clearly noticed that the ABC method is useful for the manufacturing industries but still have some drawbacks. Therefore the companies should analyze their environment correctly before opting for any of the costing techniques.

Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.

Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.

Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.

Datar, M. S. (2015). Cost accounting. Boston: Pearson.

Datar, S. (2016). Horngren’s Cost Accounting: A Managerial Emphasis. Hoboken: Wiley.

Horngren, C. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.

Menifield, C. E. (2014). The Basics of Public Budgeting and Financial Management: A Handbook for Academics and Practitioners. Lanham, Md.: University Press of America.

White, T. S. (2009). The 60 minute ABC book. Bedford: Consortium for Advanced Manufacturing International.