CAMELBACK COMMUNICATIONS

Management Accounting

2008
Contents
Synopsis:...............................................................................................................3
Answers.................................................................................................................4
Charges for 40% mark on and Product to be dropped......................................4
Recalculation of allocation rates if additional products are to be dropped......5
What is going on?..............................................................................................6
Differentiation between variable and fixed costs and maximization of
contribution.......................................................................................................7
Modified Cost system I......................................................................................7
Modified Cost System II.....................................................................................8
Camelback communications

Synopsis:

About the company:

 Manufactures radio & television antennas
 4 distinct product lines
1. Rabbit ear antennas
2. Dipole antennas for FM & TV reception
3. Rotators for the dipole line.
4. 2 electronic antennas;1 for FM & other for TV
 Last 5 years, doubled the number of products offered, expanded the production
facility twice & recently introduced the electronic antenna line.
 President Lincoln McDowell concerned about its ability to cost products accurately.
 Some products profitable whereas others impossible to manufacture at a profit.
 Cost accounting system at fault.

Glenn Peterzon, a management consultant’s observations about the company’s cost system:

 Existing cost system is simple.

 It used a single burden rate for all overhead costs.

Budgeted Variable + Fixed Overheads

Burden Rate = Number of Direct Labour Hours
Standard Cost = Direct Labour Cost + Direct Material Cost
(Direct Labour Hours * Burden Rate)

To illustrate the problem to the management he developed a Four Product Model.

 He calculated the direct labour allocation rate that the existing single burden rate
cost system would generate assuming the production to be maximum possible &
taking direct labour hour cost to be $5.
 After computing the standard cost, selling price was calculated on the basis of
40% mark-on.
 Industry selling prices were different as they were established using the actual
production costs & a 40% mark-on.
 On comparing the industry prices to the firm’s costs profitability was determined.
  The products with a mark-on of less than 25% were discontinued.
 Because of this the resulting product mix differed from the starting mix which led
to recalculation of allocation rate per hour to determine if it had been affected.

Answers
Charges for 40% mark on and Product to be dropped

Variable Labour Variable

Product Hours Per Overhead Per Total Labour
Overhead Unit Unit No. Of Units Hours Total ($)
B 1 7.5 2000 2000 15000
C 3 5 1000 3000 5000
D 2 7.5 1000 2000 7500
Total 7000 27500

New
Alocation
Rate:
Variable
Overhead 27500
Fixed
Overhead 45000
Total 72500
Labour
Hours 7000

Allocation
Rate/Hour 10.36

Product B C D
Material 5 10 5
Labour 5 15 10
Allocated
Cost 10.36 31.07 20.71
Standard
Cost 20.36 56.07 35.71
40% Mark
On 8.14 22.43 14.29
Selling
Price 28.50 78.50 50.00

Standard
Cost 27.5 42.5 35
Mark On 11 17 14
Standard
Selling
Price 38.5 59.5 49

Profit 18.14 3.43 13.29

% Markup 89.12 6.11 37.20

Hence Product C will be discontinued

Recalculation of allocation rates if additional products are to be dropped

Variable Labour Variable

Product Hours Per Overhead Per Total Labour
Overhead Unit Unit No. Of Units Hours Total ($)
B 1 7.5 3000 3000 22500
D 2 7.5 1000 2000 7500
Total 5000 30000

New
Alocation
Rate:
Variable
Overhead 30000
Fixed
Overhead 45000
Total 75000
Labour
Hours 5000

Allocation
Rate/Hour 15.00

Product B D
Material 5 5
Labour 5 10
Allocated
Cost 15.00 30.00
Standard
Cost 25.00 45.00
40% Mark
On 10.00 18.00
Selling
Price 35.00 63.00
 Standard
Cost 27.5 35
40% Mark
On 11 14
Standard
Selling
Price 38.5 49

Profit 13.50 4.00

% Markup 54.00 8.89

Hence product D is to be discontinued.

What is going on?

Table A in the case gives the actual cost incurred during the production of the items A, B, C
and D.

Camelback Communications is calculating the allocation rate by adding together all the fixed
and the variable cost for all the products together and then dividing them by the total labour
hours. Now this method of calculating the allocation rate is incorrect because

 Fixed overhead per product is fixed irrespective of the labour hours

 Fixed overhead is being divided between the 4 products in a faulty way because of
including it in the allocation rate.
 Also, the variable overhead that is calculated in this method is not correct because the
variable overhead per unit is different for different products.

Hence we can see the variation between the industry selling prices and that given by the
costing system in place.

Consequences of this costing system are as follows:

Because of wrong allocation of costs, we find that certain products are gaining because the
costs that should be truly attributed to them are being given to other products and vice versa.
Therefore the products whose costs are getting increased due to the wrong allocation are
showing less than desirable profits although there mark up is the same.

Eg.

The actual cost that should be attributed to A is $70, but due to the faulty cost system a cost
of $85 is getting attributed to it. Now the Selling price calculated based on the industry
standard remains the same and hence although the mark up is 40%, we seem to get a lower
mark up of 15% which leads to an equally profitable product being discontinued.
Differentiation between variable and fixed costs and maximization of
contribution

Modified Cost system I

If fixed costs are allocated using the current costing system and variable costs are correctly attributed
then,

Variable Labour
Product Hours Per Total Labour
Overhead Unit No. Of Units Hours
A 6 1000 6000
B 1 2000 1000
C 3 1000 3000
D 2 1000 2000
Total 12000

New
Alocation
Rate:

Fixed
Overhead 45000

Labour
Hours 12000

Allocation
Rate/Hour 3.75

Product A B C D
Material 15 5 10 5
Labour 30 5 15 10

Variable
overhead 15 7.5 5 7.5
Allocated
Cost 22.5 3.75 11.25 7.50

Standard
Cost 82.5 21.25 41.25 30
 40% Mark
On 33 8.5 16.5 12
Selling
Price 115.5 29.75 57.75 42

Standard
Cost 70 27.5 42.5 35
Mark On 28 11 17 14
Standard
Selling
Price 98 38.5 59.5 49

Profit 15.5 17.25 18.25 19

% Markup 18.78787879 81.17647059 44.24242424 63.33333333

From the above, we can see that there is very little change in the balancing of the costs of the
product and even in this case product A would get discontinued. Also, it is clearly evident from this
that the wrong allocation of variable cost has a much greater hand in the deviation of the costs from
their true value as compared to fixed costs.

Modified Cost System II