Question

5-41 ABC, implementation, whics (CMA, adapted) Plum Electronics, a division of Berry Corporation, manufactures two large-screen television models: the Mammoth, which has been produced since 2010 and sells for $990, and the Maximum, a newer model introduced in early 2012 that sells for $1,254. Based on the following income statement for the year ended November 30, 2014, senior management at Berry have decided to concentrate Plum's marketing resources on the Maximum model and to begin to phase out the Mammoth model because Maximum generates a much bigger operating income per unit. Plum Electronics Income Statement for the Fiscal Year Ended November 30, 2014 Mammoth Maximum Revenues $21,780,000 Cost of goods sold 13,794,000 3.511,200 Gross margin 7.985.000 1,504,800 Selling and administrative expense 6.413.000 1,075,800 Operating income $ 1,573,000 $ 429,000 Units produced and sold 22.000 4,000 Operating income per unit sold $ 71,50 $ 107.25 Total 28.795.000 17,305,200 9.490.000 TURBO $ 2.002.000 Mammoth Direct materials Direct manufacturing labor Machine costs" Total direct costs Manufacturing overhead costs Total cost of goods sold Total $ 5,033,600 435,600 3,484,800 $ 8,954,000 $4,840.000 $13,794,000 Per Unit $ 228 80 19.80 158.40 $ 407.00 $ 220.00 $ 627.00 Maximum Total Per Unit $2.569,600 $542.40 184,800 48.20 316,800 79.20 $3,071,200 $787.80 $ 440,000 $110.00 $3,511,200 $8270 V e rs 15 hours per and Maximum requires 35 hours per unit. The direct manufacturing labor con $130 per hour Machine costs include lease costs of the machine, repairs, and maintenance. Mammoth requires machine hours per unit and Maximum requires machine hours per unit. The machine-hour rate is $19.80 per hour Manufacturing overhead costs are located to products based on machine hours at the rate of $2750 per hour Plum's controllier, Steve Jacobs, is advocating the use of activity-based costing and activity-based manage ment and has gathered the following information about the company's manufacturing overhead costs for the year ended November 30, 2014 Activity Center (Cost-Allocation Base) Soldering (number of solder points) Shipments (number of shipments) Quality control (number of inspections) Purchase orders (number of orders) Machine power (machine-hours) Machine setups (number of setups) Total manufacturing overhead Total Activity Costs $1,036,200 946.000 1,364,000 1,045,440 63,360 825,000 $5,280,000 Units of the Cost-Allocation Base Mammoth Maximum Total 1,185,000 385,000 1,570,000 16,200 3,800 20,000 56,200 21,300 77,500 80,100 109,980 190,080 176,000 16,000 192,000 16,000 14,000 30,000

Answer 1

Answer-1:

= Cost driver rate: Activity Soldering Shipments Quality controls Purchase orders Machine power Machine setups Total costs $ 1,036,200 $ 946,000 $ 1,364,000 $ 1,045,440 $ 63,360 $ 825,000 Total units base 1,570,000 $ 20,000 $ 77,500 $ 190,080 $ 192,000 $ 30,000 $ Cost driver rate 0.66 per soldier point 47.30 per shipment 17.60 per inspection 5.50 per order 0.33 per machine hour 27.50 per setup

Answer-2:

$ 2,569,600 184,800 316,800 3,071,200 Plum Electronics Calculation of Costs of Each Model Under Activity-Based Costing Direct materials ($228.80*22,000; $642.40*4,000) $ 5,033,600 Direct labor ($13.20*1.5 hrs* 22,000; $13.20*3.5 hrs* 4,000) 435,600 Machine costs ($19.80*8 hrs* 22,000; $19.80*4 hrs* 4,000) 3,484,800 Total direct costs 8,954,000 Indirect costs: Soldering 782,100 Shipments 766,260 Quality controls 989,120 Purchase orders 440,550 Machine power 58,080 Machine setups 440,000 Total indirect costs 3,476,110 Total costs $ 12,430,110 254,100 179,740 374,880 604,890 5,280 385,000 1,803,890 $ 4,875,090 Profitability Analysis: Revenues Cost of goods sold Gross margin Mammoth $ 21,780,000 12,430,110 $ 9,349,890 Maximum $ 5,016,000 4,875,090 $ 140,910 Total $ 26,796,000 17,305,200 $ 9,490,800 Units sold Selling price per unit Cost of goods sold per unit Gross margin per unit 22,000 990.00 565.01 424.99 $ 4,000 1,254.00 1,218.77 35.23

Plum's simple costing system allocates all manufacturing over head other than machine costs on the basis of machine-hours, an output unit-level cost driver. Consequently, the more machine-hours per unit that a product needs, the greater the manufacturing overhead allocated to it. Because Mammoth uses twice the number of machine-hours per unit compared to Maximum, a large amount of manufacturing overhead is allocated to Mammoth. The ABC analysis recognizes several batch-level cost drivers such as purchase orders, shipments, and setups. Maximum uses these resources much more intensively than Mammoth. The ABC system recognizes Maximum's use of these overhead resources. Consider, for example, purchase order costs. The simple system allocates these costs on the basis of machine- hours. As a result, each unit of Mammoth is allocated twice the purchase order costs of each unit of Maximum. The ABC system allocates $440,550 of purchase order costs to Mammoth equal to $20.02 [$440,550 - 22.000] per unit) and $604,890 of purchase order costs to Maximum (equal to $151.23 [$604,890 + 4,000) per unit). Each unit of Maximum uses 8.31 ($ 151.231 $20.02) times the purchases order costs of each unit of Mammoth. Recognizing Maximum's more intensive use of manufacturing overhead results in Maximum showing a much lower profitability under the ABC system. By the same token, the ABC analysis shows that Mammoth is quite profitable. The simple costing system overcosted Mammoth and so made it appear less profitable.

Answer-3:

Clark's comments about ABC implementation are valid. When designing and implementing ABC systems, managers and management accountants need to trade off the costs of the system against its benefits. Adding more activities would make the system harder to understand and more costly to implement, but it would probably improve the accuracy of cost information, which in turn, would help Plum make better decisions. Similarly, using inspection- hours and setup-hours as allocation bases would also probably lead to more accurate cost information, but it would increase measurement costs.