2. FarmFresh produces two “Gourmet Supper” prepared meals. The company currently allocates overheads to units using a traditional method based on machine hours. The management accountant has concerns over the accuracy of the information and is considering introducing Activity Based Costing to allocate overheads to units.

 The following information relates to the budget for the year ahead:

Activities                         Budgeted Production Overhead

Food Processing                               £90,000

Batch Preparation                           £60,000

Total                                                  £150,000

Direct materials Product data                                                     GS1             GS2

Production / Sales (units)                                                         75,000         15,000

Direct materials cost per unit (£)                                            £1.90             £2.90

Direct labour hours per unit (hours)                                        0.1                 0.2

Machine hours per unit in machining process (hours)          3                     5

Number of machine Set Ups per batch of 500 meals            2                     5

It is estimated that direct labour costs will be £10 per hour for the budgeted period and a profit mark up of 35% of total product cost is added to attain the selling price.

Using the current traditional costing method the total budgeted product cost for GS1 is £4.40 and for GS2 is £7.40.

Both products are produced in batches of 500 units per batch.

The sales manager has reported that sales for GS2 have fallen, however, the sales for GS1 have risen. The sales manager has suggested that the sales price for GS2 be reduced.

The total direct materials cost, total direct labour cost and the total direct cost to produce 75,000 GS1 and 15,000 GS2 are shown below :

Direct costs                                                                                             GS1                 GS2

Output in units                                                                                     75,000             15,000

Direct materials cost per unit (£)                                                         £1.90               £2.90

Total Direct Material cost (£)                                                             £142,500         £43,500

Direct labour hours per unit (hours) @ £10 per hour                         0.1                 0.2

Direct Labour Cost per unit (£)                                                         £1.00                 £2.00

Total Direct Labour cost (£)                                                              £75,000             £30,000

Total Direct Cost (£)                                                                           £217,500          £73,500

The total number of machine hours in the food processing, the total number of batches required and the total number of machine setups in the batch preparation process to produce 75,000 GS1 and 15,000 GS2 are shown below :

                                                                                                        GS1             GS2             Total

Output in units                                                                         75,000         15,000

Machine hours per unit in food processing (hours)              3                   5

Total number of machine hours                                         225,000         75,000           300,000

Number of set ups per batch                                                     2                   5

Total number of batches (Output/batch size)                     150                 30                 180

Total number of machine setups                                          300                 150                450

Required :

(a) Using ABC revise the total budgeted production overhead cost for each of the meals by allocating the production budgeted overhead costs for the activities Food Processing and Batch Preparation based on the cost drivers machine hours and machine setups.

(b) Calculate the revised total and per unit budgeted product costs using ABC.

(c) Calculate the revised selling price for each meal using the ABC budgeted total cost and compare the results to those given by using the current traditional costing and sales price information given in the question.

(d) State, giving reasons, whether or not, the current sales price for the GS2 meal should be reduced to increase sales.

(e) Briefly, critically evaluate Activity Based Costing.