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Berry Ltd manufactures three products, X, Y and Z. Market research has identified that demand for products X and Y is relatively elastic whilst demand for product Z is relatively inelastic. Each product uses the same materials and the same type of direct labour but in different quantities. Berry Ltd uses full absorption costing and absorbs overheads on the basis of direct labour hours. Selling prices are then determined using cost plus pricing.
Budgeted production and sales volumes for X, Y and Z for the next year are 20,000 units, 16,000 units and 22,000 units respectively.
The budgeted direct costs of the three products are shown below:
Product X Y Z
� per unit � per unit � per unit
Direct materials 25 28 22
Direct labour (�12 per hour) 30 36 24
In the next year, Berry Ltd also expects to incur indirect production costs of �1,377,400, which are analysed as follows:
Cost pools � Cost drivers
Machine set up costs 280,000 Number of batches
Material ordering costs 316,000 Number of purchase orders
Machine running costs 420,000 Number of machine hours
General facility costs 361,400 Number of machine hours
The following additional data relates to each product:
Product X Y Z
Batch size (units) 500 800 400
Purchase orders per batch 4 5 4
Machine hours per unit 1�5 1�25 1�4
At a recent board meeting of Berry Ltd, there was a heated discussion on the need to improve financial performance. Berry Ltd wants to boost sales revenue in order to increase profits but its capacity to do this may limited if it uses cost plus pricing and a standard mark-up.
The Production Director argued that financial performance could be improved if the company introduced a more effective planning system in the form of a bottom up approach to the preparation of budgets. The Finance Director agreed that better cost control could lead to increased profitability. He suggested that the board should consider introducing activity-based costing (ABC) rather than the absorption costing system currently in place and it should also consider ways in which the company could monitor and assess performance on a wider basis. Many of the board members were unaware of terminology being used and requested that a paper be prepared to help them understand the technique so they could make an informed decision at the following board meeting.
a) Prepare a briefing note for the board that explains the key features of activity based costing. Within your writing, you should consider the impact on the selling prices and sales volumes of each product that absorption costing and ABC may have. You should only use figures to support your discussion.
b) Budgeting has a number of different purposes including planning, control, performance evaluation and motivation. Discuss the implications of this within Berry Ltd and how these purposes may conflict with each other.
The required word count for the assignment is 2,500 words in total. This represents 1,000 equivalent words in total for part a) and 1,500 equivalent words for part b).
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