Question

Product Costing: Department Versus ABC for Overhead 

Advertising Technologies, Inc. (ATI) specializes in providing both published and online advertising services for the business marketplace. The company monitors its costs based on the cost per column inch of published space printed in print advertising media and based on the cost per minute of telephor advertising time delivered on "The AD Line," a computer-based, online advertising service. ATI has one new competitor, Tel-a-Ad, in its local teleadvertising market; and with increased competition, ATI has seen a decline in sales of online advertising in recent years. ATI's president, Robert Beard, believes that predatory pricing by Tel-a-A has caused the problem. The following is a recent conversation between Robert and Jane Minnear, director of marketing for ATI. 

Jane: I just received a call from one of our major customers concerning our advertising rates on "The AD Line" who said that a sales rep from another firm (it had to be Tel-a-Ad) had offered the same service at $1 per minute, which is $1.50 per minute less than our price. 

Robert: It's costing about $1.35 per minute to produce that product. I don't see how they can afford to sell it so cheaply. I'm not convinced that we should meet the price. Perhaps the better strategy is to emphasize producing and selling more published ads, which we're more experienced with and where our margins are high and we have virtually no competition. 

Jane: You may be right. Based on a recent survey of our customers, I think we can raise the price significantly for published advertising and still not lose business. 

Robert: That sounds promising; however, before we make a major recommitment to publishing, let's explore other possible explanations. I want to know how our costs compare with our competitors. Maybe we could be more efficient and find a way to earn a good return on teleadvertising.

After this meeting, Robert and Jane requested an investigation of production costs and comparative efficiency of producing published versus online advertising services. The controller, Tim Gentry, indicated that ATI's efficiency was comparable to that of its competitors and prepared the following cost data: 

Published Advertising Online Advertising Estimated number of production units 200,000 10,000,000 Selling price $200 $2.50 Direct product costs $21,000,000 $5,000,000 Overhead allocation* $10,780,000 $8,470,000 Overhead per unit $54 $0.85 Direct costs per unit $105 $0.50 Number of customers 180,000 25,000 Number of salesperson days 32,000 5,500 Number of art and design hours 35,000 5,000 Number of creative services subcontract hours 100,000 25,000 Number of customer service calls 72,000 8,000 *Based on direct labor costs 

Upon examining the data, Robert decided that he wanted to know more about the overhead costs because they were such a high proportion of total production costs. He was provided the following list of overhead costs and told that they were currently being assigned to products in proportion to direct labor costs. 

Selling costs $8,250,000 Visual and audio design costs 3,300,000 Creative services costs 5,500,000 Customer service costs 2,200,000

Using the data provided by the controller, prepare analyses to help Robert and Jane in making their decisions. (Hint: Prepare cost calculations for both product lines using ABC to see whether there is any significant difference in their unit costs). Round rates to two decimal places, if needed. 

Answer 1

Activity Based Overheads Rates

Activity	Amount in $
Selling ($8,250,000/37,500)	220
Design ($3,300,000/40,000)	82.50
Creative Services($5,500,000/125,000)	44
Customer Services ($2,200,000/80,000)	27.50

Activity Based Cost Assignment
	Published ($)	Online($)
A. Selling	7,040,000	1,210,000
B. Design	2,887,500	4,12,500
C. Creative Services	4,400,000	1,100,000
D. Customer Services	1,980,000	220,000
E. Total Cost (A+B+C+D)	16,307,500	2,942,500
F. Units	200,000	10,000,000
G. Cost per Unit (E/F)	81.54	0.30

Total Production Cost per Unit Comparison
	Published ($)	Online ($)
Cost Using ABC (Direct Cost+Overhead Per Unit)	186.54	0.80
Cost using Traditional(Direct Cost+Overhead Per Unit)	159.00	1.35
Difference	27.54	-0.55

Answer 2

Solution:-
Determining cost of each product line using activity based costing:-
Overhead rate based on activity based costing
Particulars	Cost (A)	Driver (B)		Overhead rate (A/B)
Selling costs	$7,500,000	Number of sales person days	37500	$200
Visual and audio design costs	$3,000,000	Number of art and design hours	40000	$75
Creative services costs	$5,000,000	Number of creative services subcontract hours	125000	$40
Customer service costs	$2,000,000	Number of customer service calls	80000	$25
Cost of each product product line as per ABC method:-
	Published advertisement			Online Advertisement
	Cost driver	Rate	Amt.	Cost driver	Rate	Amt.
Direct product costs			$21,000,000			$5,000,000
Overheads:-
Selling costs	32000	$200	$6,400,000	5500	$200	$1,100,000
Visual and audio design costs	35000	$75	$2,625,000	5000	$75	$375,000
Creative services costs	100000	$40	$4,000,000	25000	$40	$1,000,000
Customer service costs	72000	$25	$1,800,000	8000	$25	$200,000
Total costs as per ABC method			$35,825,000			$7,675,000
÷ Total units			200000			10000000
Cost per unit			$179.13			$0.77
Cost of each product product line as per traditional method:-
	Published Advertisement	Online Advertisement
Direct product costs	$21,000,000	$5,000,000
Overhead (Traditional method)	$9,800,000	$7,700,000
Total cost (Traditional method)	$30,800,000	$12,700,000
÷ Total units	200000	10000000
Cost per unit	$154	$1.27
Difference between costs of each product line as per ABC method and traditional method:-
Product	Cost per unit as per ABC method (A)	Cost per unit as per Traditional method (B)	Under charged/(Excess charged)
Published Advertisement	$179.13	$154.00	$25.13
Online Advertisement	$0.77	$1.27	$(0.50)
Because of using traditional costing the cost of both the product line is not calculated properly, cost of product as per ABC is considered more appropriate and accurate. ABC method assigns cost to each product in the most reasonable manner i.e. on the basis of actual incurrance of a particular expense on each product. In the present case company is planning to discontinue online advertisement because its competitor is offering it for $1 per unit whereas they are selling it for $1.5 per unit. Now they were discontinuing this line because as per traditional method cost of this product line is $1.27 per unit whereas it is $0.77 per unit in reality. Thus ATI should not switch from fast growing online advertising market back into the well established published market and the charge of predatory pricing is not valid as per the table above and the reason why customers are demanding more of published advertisement is that it is charging less for this product as compared to what seems to be a valid charge for this service. No the result of traditional costing and ABC costing is not same.