Ican 2021 Performance Management Question 6

Chukwukah Nigeria Limited manufactures three products, JEL, JET and JAL. Demand for products JEL and JET is relatively elastic whilst demand for product JAL is relatively inelastic. Each product uses the same materials and the same type of direct labour but in different quantities. For many years, the company has been using full absorption costing and absorbing overheads on the basis of direct labour hours. Selling prices are then determined using cost plus pricing. This is common in the company’s industry with most competitors applying a standard mark-up. Budgeted production and sales volumes for JEL, JET and JAL for the next year are 25,000, 20,000 and 27,600 units respectively. The budgeted direct costs of the three products are shown below: Product JEL JET JAL Direct materials N per unit 250 280 220 Direct labour (N120 per hour) 300 360 240 In the coming year, Chukwukah also expects to incur indirect production costs of N6,887,000, which are analysed as follows: Cost pools N ‘ 000 Cost drivers Machine set up costs 1,400 Number of batches Material ordering costs 1,580 Number of purchase orders Machine running costs 2,100 Number of machine hours General facility costs 1,807 Number of machine hours 6,887 The following additional data relates to each product: Product JEL JET JAL Batch size (units) 500 800 400 No of purchase orders per batch 4 5 4 Machine hours per unit 1.5 1.25 1.4 The management of Chukwukah Nigeria Limited wants to boost sales revenue in order to increase profits but its capacity to do this is limited because of its use of cost plus pricing and the application of standard mark-up. The management accountant has suggested using activity based costing (ABC) instead of full absorption costing, since this will alter the cost of the products and may therefore enable a different price to be charged.