Question

Xylon Company manufactures custom-made furniture for its local market and produces a line of home furnishings sold in retail stores across the country. The company uses traditional volume-based methods of assigning direct materials and direct labor to its product lines. Overhead has always been assigned by using a plantwide overhead rate based on direct labor hours. In the past few years, management has seen its line of retail products continue to sell at high volumes, but competition has forced it to lower prices on these items. The prices are declining to a level close to its cost of production. Meanwhile, its custom-made furniture is in high demand, and customers have commented on its favourable (lower) prices compared to its competitors. Management is considering dropping its line of retail products and devoting all of its resources to custom-made furniture.

Required

1. What reasons could explain why competitors are forcing the company to lower prices on its highvolume retail products?

2. Why do you believe the company charges less for custom-order products than its competitors?

3. Does a company’s costing method have any effect on its pricing decisions? Explain.

4. Aside from the differences in volume of output, what production differences do you believe exist between making custom-order furniture and mass-market furnishings?

5. What information might the company obtain from using ABC that it might not obtain using volume-based costing methods?

Short answer

ABC method is the most accurate and preferred method of overhead allocation as it helps with cost optimization and helps in charging competitive prices from the customers.

Step-by-step solution

Meaning of Activity Based Control

Activity-based costing is a technique or method of costing that assigns accurate overhead costs after the identification of the activities of the organization.

Explanation of requirement 1

The main reason for the competitors forcing the company to lower the prices may be the competitive strategy by the competitors to step into the market. The product for company Xylon is of standard quality that must be competent in terms of competitive prices. That’s why the competitors keep their prices lower and force the company to lower the prices.

Explanation of requirement 2

The company is charging less for custom order products because the company does not want to lose the market share in terms of price. The company is making products of high quality, which is also having the highest demand, but the threat to losing the market is the pricing game by the competitors.

Explanation of requirement 3

Yes, the company’s costing method affects its pricing policy. The company is adopting the plant-wide allocation method for overheads. This method may allocate some products with higher overhead costs than the actual activity level. Thus the company may be overcharging the product due to the higher cost allocated to the custom-made products.

Explanation of requirement 4

The difference between the custom order furniture and the mass-market furnishing is the difference in overhead cost allocation. Custom-made products may require higher labor hours, lower other overheads cost, etc., but mass production requires fewer costs in terms of allocation because of economies of scale.

Explanation of requirement 5

By using the ABC method, the company may obtain the actual activity level for each indirect cost component. This information helps in making production decisions. While comparing, the company may decide which product is utilizing which activity level more and how the company can optimize the cost.

It is also an accurate overhead allocation method as it does not over-allocate or under allocate the costs.