Problerm:
ABC VERSUS ABM
Timesaver, Inc., produces deluxe and regular microwaves. Recently, Timesaver has been losing market share with its regular microwaves because of competitors offering a product with the same quality and features but at a lower price. A careful market study revealed that if Timesaver could reduce its regular model price by $10 per unit, it would regain its former share of the market. Management, however, is convinced that any price reduction must be accompanied by a cost reduction of $10 so that per-unit profitability is not affected. Earlene Day has indicated that poor overhead costing assignments may be distorting management's view of each product's cost and, therefore, the ability to know how to set selling prices. Earlene has identified the following overhead activities: machining, testing, and rework. The three activities, their costs, and practical capacities are as follows:
|
Activity
|
Cost
|
Practical Capacity
|
|
Machining
|
$1,800,000
|
150,000 machine hours
|
|
Testing
|
1,200,000
|
40,000 testing hours
|
|
Rework
|
600,000
|
20,000 rework hours
|
The consumption patterns of the two products are as follows:
|
|
Regular
|
Deluxe
|
|
Units
|
100,000
|
10,000
|
|
Machine hours
|
50,000
|
10,000
|
|
Testing hours
|
20,000
|
20,000
|
|
Rework hours
|
5,000
|
15,000
|
Timesaver assigns overhead costs to the two products using a plantwide rate based on machine hours.
Required:
1. Calculate the unit overhead cost of the regular microwave product using machine hours to assign overhead costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Timesaver's competitive problem? What did it reveal?
2. Now, assume that in addition to improving the accuracy of cost assignments, Earlene observes that defective supplier components are the root cause of both the testing and rework activities. Suppose further that Timesaver has found a new supplier that provides higher-quality components such that testing and rework costs are reduced by 50 percent. Now, calculate the cost of each product (assuming that testing and rework time are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.