Question I: Activity-Based Costing and Management:
“Big-Buck” manufactures three different types of leather bags for laptop computers – Standard, Specialty and Deluxe. On September 30th,(2006) the financial department provides a quarterly cost information summary of the three products:
|
|
Standard
Model
|
Specialty
Model
|
Deluxe
Model
|
|
Selling price
|
$30.0
|
$56.0
|
$90.0
|
|
Unit manufacturing cost
|
29.0
|
45.0
|
50.0
|
|
Gross margin per unit
|
$1.0
|
11.0
|
40.0
|
|
Quarterly Sales (units) in
|
10,000
|
2,500
|
800
|
Phil, the CEO of the company was surprised by the thin margin of the standard model ($1 per bag) and pondered about the possibility of dropping the standard model completely.
The key raw materials for a laptop bag include: leather, fabric, Synthetic materials and accessories (e.g., zippers, wheels). The company is well known for its standard model because of its quality and competitive price. Since the past three years, “Big-Buck” has been facing steadily increasing competition from imported bags from the Fareast. In response, the company decided to expand its product lines. In 2004 “Big-Buck” introduced the Specialty Model and in 2005 the Deluxe Model.
Besides the design, the key difference between the standard, specialty and deluxe models is the quality of the leather and accessories. The Specialty and deluxe models use better leather, have more pockets and accessories inside the bag and require a longer processing time. They also require more complicated setup procedures for the sewing and cutting machines.
A simple breakdown of the manufacturing costs reveals:
|
|
Standard
Model
|
Specialty
Model
|
Deluxe
Model
|
|
Direct Materials
|
|
|
|
|
Leathers
|
0
|
12.0
|
15.0
|
|
Fabric
|
2.0
|
3.0
|
3.0
|
|
Synthetic
|
9.0
|
1.0
|
1.0
|
|
Accessory
|
0.0
|
2.0
|
4.0
|
|
Total materials
|
$11.0
|
$18.0
|
$23.0
|
|
Direct Labor
|
8.0
|
12.0
|
12.0
|
|
Manufacturing OH
|
10.0
|
15.0
|
15.0
|
|
Total cost per unit
|
$29.0
|
$45.0
|
$50.0
|
The pre-determined manufacturing OH rate is calculated based on budgeted manufacturing OH divided by total direct labor dollars:
Pre-determined OH = (Budgeted manufacturing OH)/(Budgeted Direct Labor Costs) = $600,000/480,000 = 1.25
Hence, the manufacturing OH is assigned to products at a rate of $1.25 for every dollar of direct labor incurred.
Additional ANNUAL information regarding the company’s current production/planning and costing is as follows:
ANNUAL BUDGET FOR 2007
|
Model
|
Estimated
Demand
( # of bags)
|
Direct labor
Hours
(hour
perbag)
|
Batch Size
(bags
per batch)
|
Number
of setups
required
(setups
per batch)
|
Quality
Inspection
(hours
per batch)
|
Machining
Time
(hour
per bag)
|
|
Standard
|
36,000
|
0.50
|
1,000
|
2
|
100
|
0.1
|
|
Specialty
|
12,000
|
0.75
|
500
|
3
|
150
|
0.2
|
|
Deluxe
|
4,000
|
0.75
|
200
|
3
|
150
|
0.5
|
|
Key Activities
|
Overhead Costs
Annual budget
|
Proposed
Cost
Driver
|
Budgeted
activity
level
|
Practical
Capacity
|
|
Setup related OH costs
|
$160,000
|
?
|
?
|
Na
|
|
Material Handling
|
40,000
|
Number of batches
|
?
|
Na
|
|
Equipment Depreciation
(Sewing and framing)
|
300,000
|
Machining Hours
|
?
|
10,000
machine hours*
|
|
Quality inspection
|
30,000
|
Inspection Hours
|
?
|
Na
|
|
Maintenance
|
50,000
|
Machining Hours
|
?
|
10,000
machine hours*
|
|
Other Overhead costs
|
20,000
|
Assembly hours
|
?
|
Na
|
|
Total budgeted OH
|
$600,000
|
|
|
|
• In total there are four sets of equipment, each set of equipment is capable of operating 10 hours a day. We assume 50 working weeks and 5 working days per week for each machine.
After having reviewed the financial and cost reports prepared by the financial department, Phil is considering making some adjustments/changes to the product mix and pricing for the coming year (2007). The marketing department reports that demand for the Specialty and Deluxe models is growing. Customers are especially impressed by the details, top quality and design of the Deluxe bag. Conversely, the standard model is under tremendous price pressure by competitors importing bags from the Fareast. The average price from competitors is about $28 a bag. “Big-Buck” was able to hold market share because of its aggressive promotion that the bags are “Made in America.”
Phil is contemplating dropping or decreasing the volume of the Standard model and investing new resources in promoting the new Deluxe model. Before making any decision Phil decides to have the production manager Mrs. Mary Moorman, a recent graduate from ASU’s Exe MBA program, to review the report.
As a production manager, Mary knows the complexity of manufacturing the Deluxe and Specialty models. From a production manager’s perspective, the majority of resources can be redeployed freely across different models. The key constraint of the production system is the capacity of the sewing and framing equipment. Currently, this equipment is operating at 80% capacity. Expanding production of the Deluxe or Specialty Models can take away production capacity currently devoted to the Standard Model.
Requirement:
1. Based on what you have learned regarding ABC costing, please help Mary prepare a revised cost report by:
a. computing the overhead rate for various activities in the spirit of ABC
b. preparing a new cost report for the three products
c. In your opinion how many cost pools will be sufficient for the ABC analysis
2. Based upon the new cost data:
a. Do you agree with the marketing manager that “Big-Buck” is losing its competitiveness on the Standard Model?
b. Suggest ways to improve the cost structure of the Deluxe and Specialty models
3. Based on the existing cost structure (i.e. same number of setups and processing time), what are your recommendations for the product mix (i.e. Standard, Specialty and Deluxe) and the corresponding pricing strategy?