This case analysis compares traditional and modern costing systems for Fantori Limited, a sewing machine manufacturer. It includes a detailed breakdown of costs and profitability under both methods.
Contribute Materials
Your contribution can guide someone’s learning journey. Share your
documents today.
Case Analysis of Fantori Limited Introduction Fantori Limited is a well reputed company engaged in the business of manufacturing sewing machines. The company manufactures two models of sewing machine at present and sells them to external parties. The two models of sewing machines are basic model and advanced model (with some additional features). In year 2017, the company made handsome profits and the business was running quite well. The company has just entered into an unchartered territory whereby they have procured order from a foreign buyer who wishes to procure only Advance grade sewing machine of the company. This has put the company under a doubt why there has been no order for basic grade and needs to revisit its costing system. Under the present circumstance, the company use traditional method of costing i.e. absorption costing and uses Machine hours as the basis of allocation of fixed overheads to the product. However, the company is considering to implement Activity Based Costing and find the rationale for demand of only Advance sewing machines. In this regard , company ha sought a detailed analysis of Traditional Costing Method vis-a vis Modern costing system and the impact on the profits under both the methods. Traditional Costing System V/s Modern Costing System Traditional Costing system is an old concept and usually used for small enterprises. Under the said method, the indirect cost of production is allocated on the basis of a fixed rate derived on the basis of direct labour hours, machine hours etc. It does not map the correct allocation of cost to products. To overcome this shortfall, a new method of costing was devised which was intended to generate and map the indirect cost on various parameters known as pools. Thus, under the said method correct or true cost of production is derived. Further, the importance of accurate costing has been enumerated here-in-below: (a)It helps businesses in making optimal decisions; (b)It enables correct mark up on products; (c)Wrong cost estimates may lead to business losses. Thus, correct costing enables guided decision on product profitability; (d)It helps in making decisions regarding which product shall be promoted by the company to maximise its profits; (e)It helps business to stay on schedule and track (f)Healthy growth of business; (g)Cost controlling. Case Analysis Costing under Traditional Method of Costing In the present case, the company manufactures two grade of sewing machine namely Basic Grade and Advanced Grade. Under the Basic Grade model, the Company incurs a direct material cost of $ 350 and the direct labour cost of $ 175. Further, the machine hours involved in manufacturing of the said product is 4700 Hours. In addition, the total number of units manufactured by the company is 1700 units. Under the Advanced Grade model, the Company incurs a direct material cost of $ 580 and the direct labour cost of $ 280. Further, the machine hours involved in manufacturing of the said product is 3500 Hours. In addition, the total number of units manufactured by the company is 1600 units.
Secure Best Marks with AI Grader
Need help grading? Try our AI Grader for instant feedback on your assignments.
Further, the indirect cost incurred in manufacturing both models involves cost of inspection of $ 30,000, Cost of Assembly $ 1,00,000, Cost of production scheduling $ 1,10,000 and cost of machine set up is $ 40,000. In addition, there are some other indirect cost which are specific to Advance Model of Sewing Machines i.e. Selling and Administration expense of $ 3,00,200, interest expense of $ 40,500 and office rent of $ 42,800. The total of indirect expenses that needs to be allocated over two proucts stands at is $ 2,80,000 and the total machine hours involved in manufacturing both the production is 8,200 Machine hours. On the basis of the data, the computation of overhead rate per Machine Hour has been provided here-in-below: Sl. NoParticularAmount 1Inspection30000 2Assembly100000 3Production Scheduling110000 4Machine Set up40000 5Total Indirect cost280000 6Total Machine Hours8200 7Allocation Rate Per hour34.15 Further, the costing of Basic Grade Sewing Machine under the traditional method of costing using a fixed overheads rate as computed above has been provide below : Cost of Production Basic Model Sl NoParticularsBriefs In Dollar 1Unit Produced1700 2Cost of direct Material Per unit350 3Total Direct Material Cost595000 4Direct Labour Cost per unit175 5Total Direct Labour Cost297500 6Total indirect cost160487.8 7Total Cost1052988 8Cost per unit619.40 The cost per unit of the above product has been computed by dividing the total cost of production incurred for manufacturing the Basic Grade model of sewing machine by no of units produced of Basic Model. Thus, the cost per unit of Basic Grade Sewing Machine stands at $ 619.40 under traditional system of costing. Further, the costing of Advance Grade Sewing Machine under the traditional method of costing using a fixed overheads rate as computed above has been provide below : Cost of Production Advance Model Sl. NoParticularsBriefs 1Unit Produced1600 2Cost of direct Material Per unit580
3Total Direct Material Cost928000 4Direct Labour Cost per unit280 5Total Direct Labour Cost448000 6Total indrect cost allocated119512.2 7Other operating Expense -Selling and Administration300200 -Interest Expense40500 -Office Rent42800 8Total Cost1879012.2 9Cost per unit1174.38 The cost per unit of the above product has been computed by dividing the total cost of production incurred for manufacturing the Advance Grade model of sewing machine by no of units produced of Advance Grade Model. Thus, the cost per unit of Advance Grade Sewing Machine stands at $ 1174.38 under traditional system of costing. Further, there has been specific indirect cost allocated to Advance Grade Sewing Machines comprising Selling and Administration expense of $ 3,00,200, interest expense of $ 40,500 and office rent of $ 42,800. Costing under Activity Based System of Costing In the present case, the company manufactures two grade of sewing machine namely Basic Grade and Advanced Grade. Under the Basic Grade model, the Company incurs a direct material cost of $ 350 and the direct labour cost of $ 175. Further, the machine hours involved in manufacturing of the said product is 4700 Hours, Number of inspections is 210, number of production scheduling runs is 60 and the number of times of machine set up is 120. In addition, the total number of units manufactured by the company is 1700 units. Under the Advanced Grade model, the Company incurs a direct material cost of $ 580 and the direct labour cost of $ 280. Further, the machine hours involved in manufacturing of the said product is 3500 Hours, Number of inspections is 760, number of production scheduling runs is 510 and the number of times of machine set up is 270. In addition, the total number of units manufactured by the company is 1600 units. Further, the indirect cost incurred in manufacturing both models involves cost of inspection of $ 30,000, Cost of Assembly $ 1,00,000, Cost of production scheduling $ 1,10,000 and cost of machine set up is $ 40,000. In addition, there are some other indirect cost which are specific to Advance Model of Sewing Machines i.e. Selling and Administration expense of $ 3,00,200, interest expense of $ 40,500 and office rent of $ 42,800. The total of indirect expenses that needs to be allocated over two proucts stands at is $ 2,80,000 based on activity pools comprising inspections, set up, machine hours and runs. On the basis of this activity pools the allocation of cost per driver has been computed here-in-below: Allocation of indirect cost under Activity Based costing DriverCost Sl.N o.Particulars Basic Model Advance ModelCost Cost Driver Basic Model Advance Model 1Inspection2107603000030.936494.823505.2 2Assembly47003500 10000 012.2057317.0742682.93
3 Production Scheduling60510 11000 0192.9811578.998421.1 4Machine Set up12027040000102.5612307.6927692.31 Total Indirect Cost allocation87698.56192301.44 Under the above table, the inspection cost has been allocated on the basis of number of inspections carried out for both the grade which is 210 for Basic Grade Sewing Machine and 760 for advanced grade sewing machines. The cost of Assembly has been allocated on the basis of Machine Hours involved for manufacturing of both the grade which is 4700 hours for Basic Model Grade and 3700 Hours for Advance Model Grade. Thecostofproductionschedulinghasbeenallocatedonthebasisofrunsinvolvedfor manufacturing of both the grade which is 60 runs for Basic Model Grade and 510 runs for Advanced Model Grade. The cost of Machine Set up has been allocated on the basis of set up involved for manufacturing of both the grade which is 120 Machine set ups for Basic Model Grade and 270 Machine set ups for Advanced Model Grade. Further, the costing of Basic Grade Sewing Machine under the Modern costing system method of costing using a pool of cost drivers as computed above has been provide below : Cost of Production Basic Model Sl NoParticularsBriefs 1Unit Produced1700 2Cost of direct Material Per unit350 3Total Direct Material Cost595000 4Direct Labour Cost per unit175 5Total Direct Labour Cost297500 6Total indirect cost87698.6 7Total Cost980198.6 8Cost per unit576.59 The cost per unit of the above product has been computed by dividing the total cost of production incurred for manufacturing the Basic Grade model of sewing machine by no of units produced of Basic Model. Thus, the cost per unit of Basic Grade Sewing Machine stands at $ 576.59 under Activity Based system of costing. The cost has decreased by $ 42.82 per unit of Basic Grade Sewing Machine. Further, the costing of Advanced Grade Sewing Machine under the Modern costing system method of costing using a pool of cost drivers as computed above has been provide below : Cost of Production Advance Model Sl NoParticularsBriefs 1Unit Produced1600 2Cost of direct Material Per unit580
Paraphrase This Document
Need a fresh take? Get an instant paraphrase of this document with our AI Paraphraser
3Total Direct Material Cost928000 4Direct Labour Cost per unit280 5Total Direct Labour Cost448000 6Total indirect cost allocated192301.4 7Other operating Expense -Selling and Administration300200 -Interest Expense40500 -Office Rent42800 8Total Cost1951801.4 9Cost per unit1219.88 The cost per unit of the above product has been computed by dividing the total cost of production incurred for manufacturing the Advanced Grade model of sewing machine by no of units produced of Advance Model. Thus, the cost per unit of Advance Grade Sewing Machine stands at $ 1219.88 under Activity Based system of costing. The cost has decreased by $ 45.19 per unit of Advance Grade Sewing Machine. Profitability under Traditional System of Costing Vis-a Vis- Modern System of Costing Under the present case, it has been established that the sales price of the Advance Grade Sewing Machine has been quoted at 30 % markup of cost under the traditional method of costing. Based on the same the profitability of two methods of costing has been computed here-in-below: Statement showing Profitability under Traditional Method and Activity Based Costing SL NoParticularsTraditional MethodActivity Based Costing 1Cost of Production1879012.21951801.4 2Mark Up563703.7 3Selling Price2442715.92442715.9 4Profit (3-1)563703.7490914.4 5No of Units16001600 6Profit per Unit352.31306.82 On perusal of the above table, it can be inferred that profit is decreased under the Activity Based costing system, thus the foreign companies have placed order for this grade of sewing machine as the cost captured by traditional method is incorrect and company has loaded a markup of 30% on under cost computed under traditional system of costing .Further, the basis of computation of cost has been detailed above. Further, the importance of accurate costing has been enumerated here-in-below: (h)It helps businesses in making optimal decisions; (i)It enables correct mark up on products; (j)Wrong cost estimates may lead to business losses. Thus, correct costing enables guided decision on product profitability; (k)It helps in making decisions regarding which product shall be promoted by the company to maximise its profits; (l)It helps business to stay on schedule and track
(m)Healthy growth of business; (n)Cost controlling. Reason for difference in Actual Overhead and Applied Overhead Actual overhead represents the actual expenditure incurred by the company during the year or a specified period and the applied overhead is an estimated expense based on historical data and the future trend. Since the said overhead is budgeted and thus there can be variance on account of the same. Further, no one can predict the future with 100% accuracy and on account of which there shall be variance on account of variety of reasons. Thus, there is a difference in Actual Overheads and Applied overheads. The three ways to deal with under/over applied overhead has been detailed here-in-below: (a)Adjust the same against the cost of good sold; (b)Pro-rata allotment of over/ under applied overhead to work in process, Finished Goods and cost of goods sold; (c)Re computing the cost on the basis of actual data and presenting a true figure. Allocation of under Applied overhead to Work-in-processs, Finished Goods and Cost of goods sold The allocation of under applied overheads to the tune of $ 90,000 has been allocated in the following manner: Allocation of Under applied overhead Sl NoParticularAmount 1Actual Overhead300000 2Applied Overhead210000 3Under Applied Overhead90000 4Work In Process60500 5Finished Goods90000 6Cost of Goods Sold1850000 7Total (4+5+6)2000500 8Prorated Allocation Work In Process (3*4)/72721.82 Finished Goods4048.988 Cost of Goods Sold83229.19