Problem:
Product cost distortions with traditional costing, original activity-based costing analysis The Manhattan Company manufactures two models of compact disc players: a deluxe model and a regular model. The company has manufactured the regular model for years; the deluxe model was introduced recently to tap a new segment of the market. Since the introduction of the deluxe model, the company's profits have steadily declined, and management has become increasingly concerned about the accuracy of its costing system. Sales of the deluxe model have been increasing rapidly.
The current cost accounting system allocates manufacturing support costs to the two products on the basis of direct labor hours. The company has estimated that this year it will incur $1 million in manufacturing support costs and will produce 5,000 units of the deluxe model and 40,000 units of the regular model. The deluxe model requires 2 hours of direct labor, and the regular model requires 1 hour. Material and labor costs per unit and selling price per unit are as follows:
|
ITEM
|
DELUXE
|
REGULAR
|
|
Direct materials cost
|
$45
|
$30
|
|
Direct labor cost
|
20
|
10
|
|
Selling price
|
140
|
80
|
Required
(a) Compute the manufacturing support cost driver rate for this year.
(b) Determine the cost to manufacture one unit of each model.
(c) The company has decided to trace manufacturing support costs to four activities. Following are the amount of manufacturing support costs traceable to the four activities this year:
|
|
|
|
COST DRIVER UNITS DEMANDED
|
|
ACTIVITY
|
COST DRIVER
|
COST
|
TOTAL
|
DELUXE
|
REGULAR
|
|
Purchase orders
|
Number of orders
|
$180,000
|
600
|
200
|
400
|
|
Quality control
|
Number of inspections
|
250,000
|
2,000
|
1,000
|
1,000
|
|
Product setups
|
Number of setups
|
220,000
|
200
|
100
|
100
|
|
Machine maintenance
|
Machine hours
|
350,000
|
35,000
|
20,000
|
15,000
|
|
|
|
$1,000,000
|
|
|
|
Compute the total cost to manufacture one unit of each model.
(d) Compare the manufacturing activity resources demanded per unit of the regular model and per unit of the deluxe model. Why did the old costing system undercost the deluxe model?
(e) Is the deluxe model as profitable as the company thinks it is under the old costing system? Explain.
(f) What should the Manhattan Company do to improve its profitability? Consider pricing and product-level changes among your suggestions. Who should be involved in implementing your recommendations?