President of Greetings Inc., created Wall Décor unitof Greetings 3 yrs ago to increase company's revenue &profits. Wall Décor's revenues have grown quickly butappears to be losing money on Wall Décor. Ur assignment isto make Wall Décor profitable business unit.
From conversations wi/ managers of Wall Decor youlearn individual Greetings stores are very happy with the WallDécor arrangement. The stores are generating additionalsales revenue from the sale of unframed and framed prints.They are enthusiastic about this revenue source because theonline nature of the product enables them to generate revenuewithout the additional cost of carrying inventory. WallDécor sells unframed and framed prints to each store atproduct cost plus 20%. A 20% mark-up on products is a standardpolicy of all Greetings intercompany transactions. Each store isallowed to add an additional mark-up to the unframed and framedprint items according to market pressures. That is, the sellingprice charged by each store for unframed and framed prints isdetermined by each store manager. This policy ensures competitivepricing in the respective store locations, an important businessissue because of mall competition.
Store managers noted significant difference in the salesperformance of the unframed prints and the framed prints. They findit difficult to sell unframed prints at a competitive price. Onaverage, stores find that the profits on unframed prints are verylow because the cost for unframed prints charged by WallDécor to the Greetings stores is only slightly below whatcompeting stores charge their customers for unframed prints. As aresult, the profit margin on unframed prints is very low, and theoverall profit earned is small, even with the large volume ofprints sold. In contrast, stores make a very good profit on framedprints and still beat the nearest competitor's price by about 15%.That is, the mall competitors cannot meet at a competitive pricethe quality of framed prints provided by the Greetings stores. As aresult, store managers advertise the lowest prices in town forhigh-quality framed prints. One store manager referred to WallDécor's computer on the counter as a "cashmachine" for framed prints and a "lemonade stand"for unframed prints.
The Production Manger believes the relative profitability offramed and unframed prints is distorted because of improper productcosting. And that costs provided by company's traditional job-ordercosting system are inaccurate. From the very beginning, she hasmanaged production and distribution costs. She explains,"Wall Décor is essentially giving away expensiveframed prints, and it appears that it is charging the stores toomuch for unframed prints." She shows you her own productcosting system, which supports her point of view.
(IT) department provided additional insight as why WallDécor is having financial problems and that by keeping thewebsite running requires separate computer servers and severalinformation technology professionals. Two separate activities areoccurring in the technology area. First, purchasing professionalsand IT professionals spend many hours managing thousands of printsand frame and formatting materials. Their tasks include selectingprints and the types of framing material to sell. They also mustupload, manage, and download prints and framing material onto andoff of the website. The IT staff time is spent with framingand matting material. Only a highly skilled IT professional canproperly scan a print and load it up to the site so that itgraphically represents what the print will look like when properlymatted and framed.
You discover that a different team of IT professionals isdedicated to optimizing the operating performance of the website.These costs are classified as manufacturing overhead because asubstantial amount of work is required to keep the site integratedwith purchasing and production and to safeguard Wall Décor'sassets online. Most time-consuming is the effort to develop andmaintain the site so that customers can view the prints as theywould appear either unframed or framed and matted.
An IT professional suggests that the time spent developing andmaintaining the site for the unframed prints is considerably lessthan that required for the framed prints and in particular for theframed and matted prints. Developing and maintaining a site thatcan display the unframed prints is relatively straightforward. Itbecomes more complicated when the site must allow the customer toview every possible combination of print with every type of steelframe, and immensely more complicated when one considers all of thepossible wood frames and different matting colors. A verysubstantial portion of the IT professionals' time and resources isrequired to present the over 1,000 different framing and mattingoptions.
You have decided that the company's ability to measure andevaluate the profitability of individual products would be improvedif the company employed an activity-based costing (ABC) system. Asa first step in this effort, you compiled a list of costs,activities, and values. Your work consisted of taking the originalmanufacturing overhead cost ($375,200, provided in Case 1) andallocating the costs to activities. You identified four activities:picking prints; inventory selection and management (includesgeneral management and overhead); website optimization; and framingand matting cost (includes equipment, insurance, rent, andsupervisor's salary).
The first activity is picking prints. The estimated overheadrelated to this activity is $30,600. The cost driver for thisactivity is the number of prints. It is expected that the totalnumber of prints will be 102,000. This is the sum of 80,000unframed, 15,000 steel-framed, and 7,000 wood-framed.