For example, rent on the basis of floor area. The above mentioned methods are called as direct method (in case of direct identification with cost centre) and cost-driver method (i. E. Allocation on a suitable basis). Both these methods holds good only in case of firms dealing with single line products. In case of multiple products or different class of products these methods cannot be used for the following reasons: a) A single product may have a different cost driver. For example in this case wages paid to plant maintenance staff can be allocated on the basis of inspection mime or production of the plant or on the basis of number of products. ) Also the high volume products but less significant products will be over- priced if we use direct method of allocation overheads. The suitable method for firms dealing with multiple products is Activity Based Costing (BBC) Method. Under this method Overheads of a particular activity Or product is related using cost drivers and common overheads are allocated on a suitable basis. In case Of multiple cost drivers ,the most prominent or dominant cost driver is used. In the given case, the Cafe products were classified into three classes to analyze its cost competitiveness. Let us first relate the overheads with the product class.
Identification of Overheads with products Account Head Nature of Overheads I Related Class of Product Reason I Class Ill I | 1000 | Wages to Non-skilled personnel Less skilled employees will be employed for less important tasks I Salary for all plant employees except I Class and Class II | 1500 Assumed to be relevant to these classes and engineers setting up machines elaborations based on their direct labor cost 12000 Cloves, safety goggles and packing I Class II and Class AS these items are more relevant for semi-skilled I I material and unskilled labor tools and spare parts 13000 loose I Common expense to be allocated to all classes I 4000 | Indirect material (Purchased utilities) Class II Assumed as to be relevant to Class II 15000 Wages for skilled Non-Production I Class The degree Of supervision required for this class employees for supervision and maintenance list more than Other classes 8000 Property Taxes and Depreciation Common expense to be allocated to all classes 1 19000 tether Expenses I Common expense to be allocated to all classes II 1000 | Setup Cost of machinery Class I More relevant for low volume but highly important I I products 1 112000 TOT and other benefits to production I Class and Class II Same as 1500 above 1 114000 workers TOT and other benefits to skilled I Class I I Same as 5000 above minion I non-production workers referred I above Allocation of Overheads to Each Class Products (Amount in SHOO) I I Account Head 12003 12004 12005 Basis of Allocation Total OH I IA) Revenue | 226,542 | 133,422 price and Sales quantity) 86,987 | 79,393 143. 34 48,424 I I(Same as 2005 as there is no change in selling B) Cost i) Direct Expenses (as per Working below) ii) Indirect Expenses/Overheads I I(Assuming same production quantities and Overhead Allocation Rate as per Question 1) iii) Total 91 , 458 60,162 166,380 I I C) Profit 141 I I Expected Direct Expenses (Material and Labor) for the year 2006 1 12006 122422 143,352 120,613 Note: Since any increasing/decreasing trend is not observed, only simple average is used for estimating direct expenses for the year 2006. A) Overhead Allocation Rate The Overhead Allocation will not vary if no product is dropped. Since they are pre-determined and all other factors like production, selling price etc are same. However, if Manifold Product line is dropped then the Overhead Allocation rate will be reduced to the tune of reduction in Overhead expenses on account of outsourcing manifold product line.
The working is shown below: I Particulars Overhead Allocation Rate for 2005 (Class II) in Expected Overheads on account of dropping Manifold 30969 | I (79,393 . 48,424 – as per Expected costs) Percentage decrease on account of dropping Manifold ) Overhead Allocation Rate tort the year 2006 lb) Decrease 4. Would you outsource manifolds from the CAP in 2006? Why or why not? What more information would you want before reaching your final decision? There are two aspects to be considered on deciding to outsource manifolds they a) Revenue aspect, and b) Class Of the Product. Considering the effect Of revenue on dropping manifolds (refer question 3), we may outsource manifolds as it increases the profits.
But considering the expenses there is no significant increase in direct expenses or overheads. With selling prices remaining constant in the year 2006, this product will give a reasonable and regular return. Also Manifolds belonged to Class II products till 2003. Hence, CAP should try to find the defects in its production for developing it as a Class II Product and thereafter a World Class product to regain its competitive advantage. So in my view it is not worth to drop a Class II category product with assured returns and reasonable demand. It at all CAP wishes to any cost cutting operations they may employ some skilled labor for supervision of Manifolds in lieu of unskilled/ unnecessary labor.