Question

5-40 Activity-Based Costing; Customer Group Cost Analysis Franklin Furniture Inc. (FFI) manufactures bedroom furniture in sets (a set includes a dresser, two queen-size beds, and one bedside table) for use in motels and hotels. FFI has three customer groups, which it calls the value, quality, and luxury groups. The value products are targeted to low-price motels that are looking for simple furniture, while the luxury furniture is targeted to the very best hotels. The value line is attractive to a variety of hotels and motels that appreciate the combination of quality and value. Currently there has been a small increase in the quality and value lines, and an appreciable increase in demand in the luxury line, reflecting cyclical changes in the marketplace. Luxury hotels are now in more demand for business travel, while a few years ago, the value segment was the most popular for business travelers. FFI wants to be able to respond to the increased demand with increased production but worries about the increased production cost and about price setting as its mix of customers and production change. FFI has used a volume- based overhead allocation rate based on direct labor hours for some time. Direct labor cost is $15 per hour. Budgeted Cost Cost Driver Materials handling $ 349,600 Number of parts Product scheduling 160,000 Number of production orders Setup labor 216,000 Number of setups Automated machinery 1,750,000 Machine hours Finishing 619,500 Direct labor hours Pack and ship 290,400 Number of orders shipped $3,385,500 General, selling, and adm. costs $5,000,000

Answer 1

Cost Pool	Budgeted Cost	Cost Driver	Practical Capacity	Activity Rate
Material Handling	$ 349,600	Number of Parts	990,000	$ 0.35 per part
Production Scheduling	160,000	Number of Production Orders	800	$ 200 per production order
Setup Labor	216,000	Number of Setups	200	$ 1,080 per setup
Automated Machinery	1,750,000	Machine Hours	100,000	$ 17.50 per machine hour
Finishing	619,500	Direct Labor Hours	123,900	$ 5 per direct labor hour
Pack ans Ship	290,400	Number of Orders Shipped	5,000	$ 58.08 per order shipped
	$ 3,385,500

When overheads are reassigned on an activity cost basis, many products might be found to be losing money due to undercosting, and many products might be shown to lose market share due to overcosting. This changes the way the managers look at the products and the market, and they might be tempted to change the strategy.

Capital intensive projects are difficult to justify under the traditional cost system. ABC encourages the company to adopt world class manufacturing techniques.

The activity based cost system can be integrated into the Ansoff Matrix for strategic planning and development of the organization.