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 $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	$	28.95		$	43.40
Unit product cost		26.95			33.92
Gross margin per unit	$	2.00		$	9.48

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 $50 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		10,000			2,500
Direct materials:
Leather	$	8.90		$	12.90
Fabric		2.90			1.00
Synthetic		0			7.90
Total materials		11.80			21.80
Direct labor (0.50 DLH and 0.40 DLH @ $12.90 per DLH)		6.45			5.16
Manufacturing overhead (0.5 DLH and 0.4 DLH @ $17.40 per DLH)		8.70			6.96
Total cost per unit	$	26.95		$	33.92

Manufacturing overhead is applied to products on the basis of direct labor-hours. The rate of $17.40 per hour was determined by dividing the total manufacturing overhead cost for a month by the direct labor-hours:

Predetermined overhead rate	=	Manufacturing overhead	=	$104,400	=	$17.40 per DLH
		Direct labor-hours		6,000 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 10 setups for the standard items each month and 25 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 110 hours is spent inspecting the standard briefcases and 290 hours is spent inspecting the specialty briefcases.

c. A standard briefcase requires 0.5 hours of machine time, and a specialty briefcase requires 1.2 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	$	15,000
Material handling	Number of receipts		16,000
Production orders and setups	Setup-hours		6,000
Inspection	Inspection-hours		10,600
Frame assembly	Assembly-hours		16,800
Machine-related	Machine-hours		40,000
		$	104,400

	Expected Activity
Activity Measure	Standard Briefcases	Specialty Briefcases	Total
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	?	?	?
Inspection-hours	110	290	400
Assembly-hours	790	890	1,680
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

    

Answer 1

1	Setup-hours:
						Standard	Specialty	Total
	Number of setup for a month				a	10	25
	Time required per setup (in hours)				b	1	2
	Setup-hours				a*b	10	50	60
	Machine-hours:
						Standard	Specialty	Total
	Units produced each month				a	10000	2500
	Machine time required per unit (in hours)				b	0.5	1.2
	Machine-hours				a*b	5000	3000	8000
	Activity based overhead rates:
	Activity cost pools				Estimated overhead	Cost driver		Estimated use of cost drivers	Overhead rate
					a			b	a/b
	Purchasing				15000	Number of orders		300	50	Per order
								(60+90+150)
	Material handling				16000	Number of receipts		400	40	per receipt
								(80+105+215)
	Production orders and setups				6000	Setup-hours		60	100	Per setup hour
	Inspection				10600	Inspection-hours		400	26.5	per inspection hour
	Frame-assembly				16800	Assembly-hours		1680	10	Per assembly hour
	Machine -related				40000	Machine-hours		8000	5	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				50	120	6000	50	180	9000
						(50+70)			(10+20+150)
	Material handling				40	155	6200	40	245	9800
						(70+85)			(10+20+215)
	Production orders and setups				100	10	1000	100	50	5000
	Inspection				26.5	110	2915	26.5	290	7685
	Frame-assembly				10	790	7900	10	890	8900
	Machine -related				5	5000	25000	5	3000	15000
	Total overhead assigned			e			49015			55385
	Units produced each month			f			10000			2500
	Manufacturing overhead cost per unit (e/f)						4.90			22.15
2	Unit product cost:
						Standard	Specialty
	Direct materials (total)					11.8	21.8
	Direct labor					6.45	5.16
	Manufacturing overhead			(Refer 1)		4.9	22.15
	Total					23.15	49.11
3						Standard briefcase	Specialty briefcase
	Selling price per unit				a	28.95	43.4
	Unit product cost				b	23.15	49.11
	Gross margin per unit				a-b	5.8	-5.71