Activity-Based Costing at The New Millennium Manufacturing Company

Outline

This module deals with the application of activity-based costing. The company selected for the study is The New Millennium Manufacturing Company which produces two types of products. One is a millennium surf kit. The other product is a professional surf- board (short board). In order to find out the actual profitability of the two products produced by the company, activity-based costing techniques are applied.

Introduction

The New Millennium Manufacturing Company produces two types of products. One is a millennium surf kit. The second product of the company is professional surfboards with export qualities used in world class surfing competitions. A major part of the profit of the company is derived from the sales of millennium surf product whereas recently there is an increasing demand trend in the market for professional boards. In this situation it is better to identify the actual profitability of each of these two products through applying the activity-based costing techniques. “Activity Based Costing (ABC) is an accounting technique that allows an organization to determine the actual cost associated with each product and service produced by the organization without regard to the organizational structure.” (Pandya, 2005).

Activity based costing is better to identify the true profitability of the products and services offered by the company. It is also helpful for identifying the non-value-added activities in the production process and thus cost can be reduced by eliminating the unnecessary cost elements and improving the productive efficiency.

Calculate the manufacturing overhead rate based on labor hours and machine hours (two separate computations).

Direct labor hour rate = Overhead cost of the department / total labor hours of the department.

Millennium Surf Kit:

Overhead cost of the department = $ 70 * 1500 = $105000

Total labor hours of the department = 6* 1500 = 9000

Then, LHR = 105000 / 9000 = $11.7

Professional Board:

Overhead cost of the department = $ 90 * 500 =$ 45000

Total labor hours of the department = 9 * 500 = 4500

Then, LHR = 45000 / 4500 = $10

Machine hour rate:

Machine hour rate = Overheads of the machine / number of productive machine hours.

Millennium Surf Kit:

Overhead cost of the machine = $ 90000

Number of productive machine hours = 7500

Then, MHR = 90000/ 7500 = $ 12

Professional Board:

Overhead cost of the machine = $ 90000

Number of productive machine hours = 4000

Then, MHR = 90000/ 4000 = $22.5

Q2. Determine the cost to manufacturing one unit of each model using two different traditional approaches; direct labor hours and machine hours

Surf kit:

LHR = $11.7

Then labor cost per unit = 6 * 11.7 = $70.2

MHR = $12

Then machine cost per unit = 5 * 12 = $60

Prof. Board:

LHR = $10

Then labor cost per unit = 9* 10 =$ 90

MHR = $22.5

Then machine cost per unit = 8* 22.5 = $180

Determine the cost to manufacturing one unit of each model using the activity-based costing data presented above.

Table 1. Cost sheet on Millennium Surf Kit

Table 2. Cost sheet on Professional Board.

Is the millennium surf kit as profitable as the company may think it is based on its present system?

Millennium surf kit is a highly profitable product for the New Millennium Manufacturing Company. The activity-based cost sheet on the millennium surf Kit reveals that it involves production cost of $ 412.2 per unit. The sales price per unit of the product is $ 980. Then the net profit over the unit product is of $ 567.8. Thus it can be concluded that the millennium surf product is a highly profitable product for the company.

“The implementation of ABC can make the employees understand the various costs involved. This will then enable them to analyze the cost, and to identify the activities that add value and those that do not add value.” (Analyzing product and customer profitability. Explanation of activity-based costing, 2009).

What should Millennium Manufacturing Company do to improve its profitability?

The first product of the company millennium surf kit is a highly profitable product whereas the second product professional board is only a minimal profitable product. In order to improve the profitability of Millennium Manufacturing Company, it is necessary to reduce the production cost of second product the professional board through application of advanced technologies and at the same time the sales price per unit has to be increased. In the period of increasing sales of the second product the sales price increasing policy should be adopted by the company.

“ABC is a costing model that identifies the cost pools or activity centers, in an organization and assigns costs to products and services (Cost drivers) based on the number of events or transactions involved in the process of providing a product or service.” (Activity based costing method ABC methodology, 2009).

Conclusion

The analysis of the profitability of the two products produced by the New Millennium Manufacturing Company on the basis of activity cost analysis reveals that the first product, the millennium surf kit, is a highly profitable product as it generates profit of an amount of $ 567.8 per unit. The company achieved this high-level profit for the product through charging higher selling price per unit. In case of the second product professional board, the profitability is only minimal as the selling price of the product just covers the production cost of the product. Thus, the company has to increase the selling price of the product and reduce the production cost.

References

1. Analyzing product and customer profitability. Explanation of activity based costing: Continuous improvement. (2009). 12Manage: The Executive Fast Track.
2. Activity based costing method ABC methodology: Activity based costing (ABC): Analyzing product and customer profitability: (Time-driven) activity-based costing. (2009). Value based management.net. Web.
3. Pandya, Bhargav. (2005). Understanding activity-based costing: Introduction. Indianmba. Web.