Question

"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 $9 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	$	28.65		$	43.30
Unit product cost		26.65			33.84
Gross margin per unit	$	2.00		$	9.46

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 $51 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	$	8.80		$	12.80
Fabric		2.80			1.20
Synthetic		0			7.80
Total materials		11.60			21.80
Direct labor (0.50 DLH and 0.40 DLH @ $12.80 per DLH)		6.40			5.12
Manufacturing overhead (0.5 DLH and 0.4 DLH @ $17.30 per DLH)		8.65			6.92
Total cost per unit	$	26.65		$	33.84

Manufacturing overhead is applied to products on the basis of direct labor-hours. The rate of $17.30 per hour was determined by dividing the total manufacturing overhead cost for a month by the direct labor-hours:

Predetermined overhead rate	=	Manufacturing overhead	=	$197,220	=	$17.30 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 260 hours is spent inspecting the standard briefcases and 340 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		18,870
Frame assembly	Assembly-hours		16,600
Machine-related	Machine-hours		115,850
		$	197,220

	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	260	340	600
Assembly-hours	780	880	1,660
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.

    

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.)

	Standard Briefcases Specialty Briefcases Manufacturing overhead cost per unit

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.)

	Standard Briefcases Specialty Briefcases Unit product cost

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 Gross margin (loss) per unit

Answer 1

1. Amount of manufacturing overhead cost that would be assigned to each standard briefcase and each specialty briefcase is as shown below:

	Standard Briefcase		Specialty Briefcase		Total
	Activity	Cost	Activity	Cost
Purchasing $50 per order
Leather	50	2500	10	500	3000
Fabric	70	3500	20	1000	4500
Synthetic material	0	0	150	7500	7500
Material handling @40 per receipt					0
Leather	70	2800	10	400	3200
Fabric	85	3400	20	800	4200
Synthetic material	0	0	215	8600	8600
Production orders and setups	10	1000	50	5000	6000
Inspection	150	5325	250	8875	14200
Frame assembly	680	6800	780	7800	14600
Machine-related	5000	20000	3000	12000	32000
					97800

working Notes:

Activity Cost Pool	Activity Measure	Estimated Overhead Cost	Expected Activity
Purchasing	Number of orders	15,000	300	50
Material handling	Number of receipts	16,000	400	40
Production orders and setups	Setup-hours	6,000	60	100
Inspection	Inspection-hours	14,200	400	35.5
Frame assembly	Assembly-hours	14,600	1,460	10
Machine-related	Machine-hours	32,000	8,000	4

Expected Activity
Activity Measure	Standard	Specialty	Total
	Briefcases	Briefcases
Number of orders:
Leather	50	10	60
Fabric	70	20	90
Synthetic material	0	150	150
Number of receipts:
Leather	70	10	80
Fabric	85	20	105
Synthetic material	0	215	215
Setup-hours	10	50	60
Inspection-hours	150	250	400
Assembly-hours	680	780	1,460
Machine-hours	5000	3000	8000

2.

unit product cost of each product line from the perspective of the activity-based costing.

	Standard	Specialty
	Briefcases	Briefcases
Units produced each month	10,000	2,500
Direct materials:
Leather	7.8	11.8
Fabric	1.8	1
Synthetic	0	6.8
Total materials	9.6	19.6
Direct labor	5.9	4.72
(0.50 DLH and 0.4 DLH @ $11.80 per DLH)
Manufacturing overhead	4.5325	20.99
Total manufacturing overhaed	45325	52475
	4.5325	20.99
Total cost per unit	20.0325	45.31

3.

profit

Sales	25.65	42.30
Less: Cost	20.03	45.31
Profit per unit	5.62	-3.01

Standard briefcase are generating profits.