Problem:
Drilling Innovations, Inc., produces specialized cutting heads used by companies that drill for oil and natural gas. The company has recently implemented an ABC system for three of its products and is interested in evaluating its effectiveness before converting to an ABC system for all products. To perform this evaluation, the company compiled data for the three products using both the traditional system and the new ABC system. The traditional system used a single driver (machine hours). The ABC system uses a variety of cost drivers related to the activities used to produce the cutting heads. The three products involved in the trial run of the ABC system were GS-157, HS-241, and OS-367. The following data relate to these products; unit data have been rounded to the nearest penny.
Product Selling Price Units Produced Total Costs Cost per Unit: Total Cost Costs per
Per unit Allocated: Traditional Allocated: Unit:
Traditional Costing ABC ABC
Costing
GS-157 $19.30 120,000 $1,600,000 $13.33 $1,500,000 $12.50
HS-241 $17.50 90,000 $1,100,000 $12.22 $1,050,000 $11.67
OS-367 $15.10 40,0000 $400,000 $10.00 $550,000 $13.75
Totals $3,100,000 $3,100,000
Question 1)
a. Determine the gross profit margin for each product produced based on the ABC data [(Selling price 2 ABC cost per unit) 3 Units produced].
b. Determine the gross profit margin for each product produced based on the traditional costing data [(Selling price 2 Traditional cost per unit) 3 Units produced].
c. Provide an explanation as to why the cost of OS-367 may have increased under the ABC system while the cost of GS-157 decreased.
d. Suggest what action management might take with respect to the discoveries resulting from the ABC versus traditional costing analysis. Assume that Drilling Innovations expects to produce a gross profit margin on each product of at least 30 percent of the selling price.
Question 2) Describe the production characteristics (for example, high-volume, specialty, etc.) of the three products manufactured by Pressure Products, Inc. in our case study.
Question 3) Describe the characteristics of products which would suggest it would be better to use ABC as an indirect cost allocation method over a traditional method such as direct labor hours.