Cilia Corporation specializes in the production of door knobs, which are mostly sold within its territory

Question

The selling price for each door knob is $15. Using the traditional allocation method to allocate manufacturing overhead, the full-product cost is determined to be $10. The company recently introduced the activity-based costing method to allocate its overhead. The refinement of costs shows that the full-product cost is $2.50 lower with activity-based costing than with traditional costing.
Requirement:
1. Calculate the change in net profit percentage as a result of the introduction of activity-based costing.
2. The desired net profit margin of the company is 60%. If the production costs cannot be reduced, by how much should the selling price be increased in order to achieve the desired profit? (Use the cost estimates under activity-based costing.)
What will be an ideal response

Answer 1

1.
Traditional allocation ABC Allocation
Sales Revenue $15.00 $15.00
Full-product costs 10.00 7.50
Net Profit $5.00 $7.50
Net Profit Percentage 33.33% 50.00%
The change in net profit percentage is 16.67%.

2.
Desired profit = 60%. Therefore, target price = $7.50 / (1 - 0.60 )
Target price = $18.75
The company will have to increase its selling price by $3.75 ($18.75 - $15.00 ) in order to achieve the desired profit.