Question

Fellco Manufacturing Part 240 Part 390 Product profit per unit Selling price per unit 30.00 $ 25.00 Direct materials per unit 3.00 1.50 Direct labor per unit 5.00 4.50 Overhead per unit* 12.83 5.77 Total cost per unit 20.83 11.77 Gross profit per unit 9.17 $ 13.23 * Calculated using a plant-wide rate based on direct labor hours. Production activities Part 240 500,000 100 400 Production in units Number of production runs Number of receiving orders Machine hours Direct labor hours Engineering hours Material moves Part 390 100,000 200 1,000 60,000 22,500 5,000 400 125,000 250,000 5,000 500 $ Costs of activities Setup costs Machine costs Receiving costs Engineering costs Materials handling costs Total 240,000 1,750,000 2,100,000 2,000,000 900,000 6,990,000 $

Cost Accounting

Assignment 1

Fellco Manufacturing

Fellco Manufacturing produces replacement parts for motorcycles. They specialize in the production of Part 240 and Part 390. Part 240 is the highest volume of the two and for many years was the only part the company produced. Four years ago, Part 390 was added. Part 390 is much more difficult to manufacture and requires special tooling and setups. Profits were on the rise for the first two years after the addition of Part 390. In the last two years the plant was under intense competition, and its sales of Part 240 dropped. The plant actually showed a small loss in the most recent reporting period. Most of the competition was from overseas, and the plant manager was sure that the foreign producers were selling the part below their own production costs. The following conversation between Kathryn Gonzales, plant manager, and Jon Jones, divisional marketing manager, reflects the concerns of the division about the future of the plant and its products.

JON: You know, Kathryn, the divisional manager is really concerned about the plant’s trend. He indicated that in this budgetary environment, we can’t afford to carry plants that don’t show a profit. We shut one down just last month because it couldn’t handle the competition.

KATHRYN: Joe, you and I both know that Part 240 has a reputation for quality and value. It has been a mainstay for years. I don’t understand what is happening.

JON: I just received a call from one of our major customers concerning Part 240. She said that a sales representative from another company offered the part at $20, $10 less than what we charge. It’s hard to compete with a price like that. Perhaps the plant is simply obsolete.

KATHRYN: No. I don’t buy that. From my sources, I know we have good technology. We are efficient. And it’s costing us around $21 to produce that part. I don’t see how these companies can afford to sell it so cheaply. I’m not convinced that we should meet the price. Perhaps a better strategy is to emphasize producing and selling more of Part 390. Our margin is high on this product, and we have virtually no competition for it.

JON: You may be right. I think we can increase the price significantly and not lose business. I called a few customers to see how they would react to a 25% increase in price, and they all said they would probably purchase the same quantity as before.

KATHRYN: It sounds promising. However, before we make a major commitment to Part 390, I think we had better explore other possible explanations. I want to know how our production costs compare to those of our competitors. Perhaps we could be more efficient and find a way to earn our normal return on Part 240. The market is so much bigger for this part. I’m not sure we can survive with only Part 390. Besides, my production people hate that part. It’s very difficult to produce.

After her meeting with Jon, Kathryn requested an investigation of the production costs and comparative efficiency. She received approval to hire a consulting group to make an independent investigation. After a 3-month assessment, the consulting group provided the costs and other information regarding the company’s two products. That information is found on the spreadsheet called “Fellco Manufacturing.”

Required:

NOTE: You should have two items to place in the dropbox:

1. (8 points) Based on the information given about the company and the information found in the spreadsheet, prepare an Excel spreadsheet that includes:
   1. The activity based costing rates for each activity
   2. The total and per unit product cost for each product – include each cost item separately.
   3. The gross profit for each product using activity based costing, in total and per unit.

The numeric solution should be completed on the spreadsheet provided. I will be reviewing the spreadsheet for:

• Proper formatting. Assume that this is a report you will be providing to Kathryn, who is your direct supervisor. Information should be easy to read and fairly self-explanatory. Properly including dollar signs, commas, decimals where appropriate, and so on is necessary.
• Proper use of spreadsheet functions – copying, addition, subtraction – where appropriate. All fields should be set up so a change to the Data Sheet will flow through to all calculations. When I click on “Show Formulas” every cell should be a formula with no hard coded numbers. Set up your formulas to always reference back to numbers on the Data Sheet, a previous calculation or to previous spreadsheet pages. Add to your Data Sheet if necessary so this is possible. (loss of 3 pts)
• Correct answers (of course)

2. (12 Points) Given what you have discovered, provide a memo to Kathryn Gonzales that provides:
   • An explanation as to how activity based costing is different from the current product cost method (2 points)
   • A discussion of whether the company should switch its emphasis from Part 240 to Part 390 (2 points)
   • A possible explanation as to why competitors are selling Part 240 below Fellco’s current cost of $21 and the willingness of customers to accept a 25% increase in the selling price of Part 390. Assume that the competitors are currently selling Part 240 for $20 and Part 390 for $45. (2 pts)
   • A discussion of actions that Kathryn and Jon should take with these products regarding:
     • pricing,
     • cost reductions in the cost per unit of activity
     • process improvements in the usage of activity per product.
     • Be specific. (6 points)

• The memo to Kathryn should be prepared in a Word document. Please use proper formatting, spelling, and grammar. I will be looking for your CLEAR, CONCISE, explanations.
• Remind why you are writing and summarize your recommendations in the opening paragraph, go on to explain your recommendations through your response to the points laid out above. Finally, restate your conclusions.
• Don’t just look at the obvious. Remember, you are in a competitive environment. Assume this memo is for your direct supervisor. You feel you have a future at this company, and you should want to do a good job.

Answer 1

1. Computation of Cost per unit and Gross profut as per Activity Based Costing

Cost of Activities	Amount($)	Basis	No. Of Activity	Cost per Unit
Setup Cost	240000	Production runs	(100+200=300)	800
Machine Cost	1750000	Machine Hour	185000	9.46
Receiving Cost	2100000	Receiving order	1400	1500
Engineering Cost	2000000	Engineering Hours	10000	200
Matetial Handling Cost	900000	material move	900	1000

2.Overhead Cost Per Unit of each Product

Cost of Activity	Part 240	Part 390
Setup Cost	80000	160000
Machine Cost	1183000	567000
Receiving Cost	600000	1500000
Engineering Cost	1000000	1000000
Material Handling Cost	500000	400000
Total. (A)	3363000	3627000
No. of Units. (B)	500000	100000
Overhead Per Unit (A/B)	6.73	36.27

3.Computation of total and per unit cost of each product

Product profit per unit	Part 240	Part 390
Selling Price per unit	$ 30	$ 25
Cost Per Unit
(i) Direct Material Per Unit	3	1.5
(ii) Direct labor Per Unit	5	4.5
(iii) Overhead Per Unit (W.No-2)	6.73	36.27
Total cost per Unit	14.73	42.27
Gross Profit per Unit	15.27	(17.27)

Point No 1 Answer: The Activity based Costing is different from current product cost method.In Activity costing we allocate the overhaed cost usage of overhead cost per activity.

Point No 2 Answer : No company should not switch emphasis from part 240 to part 390 because gross profit per unit part 390 is less in comparison of gross profit per unit of part 240.