Question

Analytical Thinking [LO4-2, LO4-3, LO4-4]

"Two dollars of gross margin per briefcase? That's ridiculous!" roared Roy Thurmond, president of First-Line Cases, Inc. "Why do we go on producing those standard briefcases when we’re able to make over $12 per unit on our specialty items? Maybe it’s time to get out of the standard line and focus the whole plant on specialty work."

Mr. Thurmond was referring to a summary of unit costs and revenues that he had just received from the company’s accounting department:

	Standard Briefcases			Specialty Briefcases
Selling price per unit	$	23.25		$	41.50
Unit product cost		21.25			28.80
Gross margin per unit	$	2.00		$	12.70

FirstLine Cases produces briefcases from leather, fabric, and synthetic materials in a single plant. The basic product is a standard briefcase that is made from leather lined with fabric. The standard briefcase is a high-quality item and has sold well for many years.

Last year, the company decided to expand its product line and produce specialty briefcases for special orders. These briefcases differ from the standard in that they vary in size, they contain the finest leather and synthetic materials, and they are imprinted with the buyer’s name. To reduce labor costs on the specialty briefcases, automated machines do most of the cutting and stitching. These machines are used to a much lesser degree in the production of standard briefcases.

"I agree that the specialty business is looking better and better," replied Beth Mersey, the company's marketing manager. "And there seems to be plenty of demand out there, particularly because the competition hasn't been able to touch our price. Did you know that Velsun Company, our biggest competitor, charges over $45 a unit for its specialty items? Now that’s what I call gouging the customer!"

A breakdown of the manufacturing cost for each of FirstLine Cases’ products is given below:

	Standard Briefcases			Specialty Briefcases
Units produced each month		20,000			3,500
Direct materials:
Leather	$	7.00		$	11.00
Fabric		1.00			1.20
Synthetic		0			6.00
Total materials		8.00			18.20
Direct labor (0.50 DLH and 0.40 DLH @ $11.00 per DLH)		5.50			4.40
Manufacturing overhead (0.5 DLH and 0.4 DLH @ $15.50 per DLH)		7.75			6.20
Total cost per unit	$	21.25		$	28.80

Manufacturing overhead is applied to products on the basis of direct labor-hours. The rate of $15.50 per hour was determined by dividing the total manufacturing overhead cost for a month by the direct labor-hours:

Predetermined overhead rate	=	Manufacturing overhead	=	$176,700	=	$15.50 per DLH
		Direct labor-hours		11,400 DLHs

The following additional information is available about the company and its products:

a. Standard briefcases are produced in batches of 1,000 units, and specialty briefcases are produced in batches of 100 units. Thus, the company does 20 setups for the standard items each month and 35 setups for the specialty items. A setup for the standard items requires one hour, whereas a setup for the specialty items requires two hours.

b. All briefcases are inspected to ensure that quality standards are met. Each month a total of 230 hours is spent inspecting the standard briefcases and 270 hours is spent inspecting the specialty briefcases.

c. A standard briefcase requires 0.6 hours of machine time, and a specialty briefcase requires 1.3 hours of machine time.

d. The company is considering the use of activity-based costing as an alternative to its traditional costing system for computing unit product costs. The activity-based costing system has already been designed and costs have been allocated to the activity cost pools. The activity cost pools and activity measures are detailed below:

Activity Cost Pool	Activity Measure	Estimated Overhead Cost
Purchasing	Number of orders	$	9,900
Material handling	Number of receipts		25,200
Production orders and setups	Setup-hours		10,800
Inspection	Inspection-hours		18,500
Frame assembly	Assembly-hours		13,000
Machine-related	Machine-hours		99,300
		$	176,700

	Expected Activity
Activity Measure	Standard Briefcases	Specialty Briefcases	Total
Number of orders:
Leather	60	20	80
Fabric	80	30	110
Synthetic material	0	140	140
Number of receipts:
Leather	65	20	85
Fabric	80	30	110
Synthetic material	0	225	225
Setup-hours	?	?	?
Inspection-hours	230	270	500
Assembly-hours	600	700	1,300
Machine-hours	?	?	?

Required:

1. Using activity-based costing, determine the amount of manufacturing overhead cost that would be assigned to each standard briefcase and each specialty briefcase.

2. Using the data computed in part (1) above and other data from the case as needed, determine the unit product cost of each product line from the perspective of the activity-based costing system.

3. Within the limitations of the data that have been provided, evaluate the president’s concern about the profitability of the two product lines.

Required 1

Using activity-based costing, determine the amount of manufacturing overhead cost that would be assigned to each standard briefcase and each specialty briefcase. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Manufacturing overhead cost per unit of:

Standard Briefcases_______

Specialty Briefcases_______

Required 2 Using the data computed in requirement 1 and other data from the case as needed, determine the unit product cost of each product line from the perspective of the activity-based costing system. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Unit Product Cost of: Standard Briefcases _________                                     Specialty Briefcases_________ Required 3 Within the limitations of the data that have been provided, evaluate the president’s concern about the profitability of the two product lines. (Loss amounts should be indicated with a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.) Standard Briefcases _________                                     Specialty Briefcases_________

Answer 1

1	Setup-hours:
						Standard	Specialty	Total
	Number of setup for a month				a	20	35
	Time required per setup (in hours)				b	1	2
	Setup-hours				a*b	20	70	90
	Machine-hours:
						Standard	Specialty	Total
	Units produced each month				a	20000	3500
	Machine time required per unit (in hours)				b	0.6	1.3
	Machine-hours				a*b	12000	4550	16550
	Activity based overhead rates:
	Activity cost pools				Estimated overhead	Cost driver		Estimated use of cost drivers	Overhead rate
					a			b	a/b
	Purchasing				9900	Number of orders		330	30	Per order
								(80+110+140)
	Material handling				25200	Number of receipts		420	60	per receipt
								(85+110+225)
	Production orders and setups				10800	Setup-hours		90	120	Per setup hour
	Inspection				18500	Inspection-hours		500	37	per inspection hour
	Frame-assembly				13000	Assembly-hours		1300	10	Per assembly hour
	Machine -related				99300	Machine-hours		16550	6	per machine hour
	Assignement of overhead cost:
	Activity cost pools				Standard			Specialty
					Overhead rate	Use of cost drivers	Overhead assigned	Overhead rate	Use of cost drivers	Overhead assigned
					a	b	a*b	c	d	c*d
	Purchasing				30	140	4200	30	190	5700
						(60+80)			(20+30+140)
	Material handling				30	145	4350	30	275	8250
						(65+80)			(20+30+225)
	Production orders and setups				120	20	2400	120	70	8400
	Inspection				37	230	8510	37	270	9990
	Frame-assembly				10	600	6000	10	700	7000
	Machine -related				6	12000	72000	6	4550	27300
	Total overhead assigned			e			97460			66640
	Units produced each month			f			20000			3500
	Manufacturing overhead cost per unit (e/f)						4.87			19.04
2	Unit product cost:
						Standard	Specialty
	Direct materials (total)					8	18.2
	Direct labor					5.5	4.4
	Manufacturing overhead			(Refer 1)		4.87	19.04
	Total					18.37	41.64
3						Standard briefcase	Specialty briefcase
	Selling price per unit				a	23.25	41.5
	Unit product cost				b	18.37	41.64
	Gross margin per unit				a-b	4.88	-0.14