Question

External Linkages, Activity-Based Supplier Costing Jackson, Inc., manufactures motorcycles. Jackson produces all the components necessary for the production of the cycles except for one (a carburetor). This component is purchased from two local suppliers: Harvey Parts and Curtis, Inc. Harvey sells the component for $63 per unit, while Curtis sells the same component for $56. Because of the lower price, Jackson purchases 75 percent of its components from Curtis Jackson purchases the remaining 25 percent from Harvey to ensure an alternative source. The total annual demand is 160,000 carburetors. Harvey's sales manager is pushing Jackson to purchase more of its units, arguing that its component is of much higher quality and so should prove to be less costly than Curtis's lower quality component. Harvey has sufficient capacity to supply all the carburetors needed and is asking for a long-term contract. With a five-year contract for 120,000 or more units, Harvey will sell the component for $60 per unit with a contractual provision for an annual product specific inflationary adjustment. Jackson's purchasing manager is intrigued by the offer and wonders the higher quality carburetor actually does cost less than the lower quality Curtis carburetor. To help assess the cost effect of the two products, the following data were collected for quality related activities and suppliers: I. Activity data: Activity Cost $ Inspecting components (sampling only) Expediting work (due to late delivery) 102,000 155,000 987,540 Reworking products (due to failed component) 1,767,050 Warranty work (due to failed component) II. Supplier data: Harvey Curtis Unit purchase price $63 $56 Units purchased 40,000 120,000

Answer 1

1	Activity rates:
	Activity			Cost	Activity driver		Cost	Activity rate
				a			b	a/b
	Inspecting components			182800	Sampling hours		4570	40	Per sampling hour
							(110+4460)
	Expediting work			155000	Expediting orders		310	500	Per expediting order
							(40+270)
	Reworking products			987540	Rework hours		4530	218	Per rework hour
							(300+4230)
	Warranty work			1767050	Warranty hours		5990	295	Per warranty hour
							(330+5660)
	Cost allocated=Activity rate*Activity driver for the product
						Harvey	Curtis
	Purchase cost					2520000	6720000
						(40000*63)	(120000*56)
	Inspecting components					4400	178400
						(40*110)	(40*4460)
	Expediting work					20000	135000
						(500*40)	(500*270)
	Reworking products					65400	922140
						(218*300)	(218*4230)
	Warranty work					97350	1669700
						(295*330)	(295*5660)
	Total supplier cost				a	2707150	9625240
	Units supplied				b	40000	120000
	Unit cost				a/b	67.7	80.2
	Purchase manager should purchase more units from Harvey since cost per unit is lesser for harvey compared to Curtis.
2	Warranty hours would be the best driver to allocate cost of lost sales
	Activity rate=Cost of lost sales/Warranty hours=3216630/5990=$ 537 per warranty hour
							Curtis
	Cost of lost sales allocated			(537*5660)		a	3039420
	Units supplied					b	120000
	Increase in unit cost					a/b	25.3