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 $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 Specialty Briefcases Briefcases $ 24.15 $ 41.80 22.15 29.64 Selling price per unit Unit product cost Gross margin per unit S 2.00 $ 12.16 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 $46 a unit for its specialty items? Now that's what I call gouging the customer!"

Answer 1

- Only difference between Traditional costing and Activity based costing (ABC costing) is calculation of manufacturing overheads.

- In Traditional costing, we use predetermined overhead rate for calculation of manufacturing overhead allocation.

- In ABC costing, we use activity drivers for calculation of manufacturing overhead allocation.

Coming to the problem, we need to calculate of cost per unit of the products by using ABC costing.

Calculation of cost per activity driver:

Firstly we arrange given data in a proper way     

Table 1                                                           

Particulars (A)	Standard (B)	Speciality (C)	Total (D)
Number of orders	60+80+0 = 140	20+30+140= 190	330
Number of receipts	65+80+0 = 145	20+30+225 = 275	420
Setup hours	20*1 = 20 (For standard, given that 20setups and each take 1 hour)	35*2 = 70 (For speciality, given that 35 setups and each take 2 hours)	90
Inspection hours	280	370	650
Assembly-hours	630	730	1360
Machine hours	6*20000= 120000 (It is given that standard require 6 hours of machine time) Total units = 20000 Hours per unit = 6 Total =20000*6=120000	1.3*3500 = 4550 (It is given that Speciality require 1.30 hours of machine time) Total units = 3500 Hours per unit = 1.3	124550

Now, by using above data we calculate cost per activity driver

Table 2

Activity driver (E)	Total cost (F)	Driver name (G)	Total measure (H)	Cost per activity driver (I)
Purchasing	9900	No of orders	3300	9900/30 = 30
Material handling	25200	No of receipts	420	25200/420= 60
Production orders and setups	10800	Set-up hours	90	10800/90 = 120
Inspection	21320	Inspection hours	650	21320/650= 32.8
Frame assembly	13600	Assembly-hours	1360	13600/1360= 10
Machine related	99300	Machine hours	124550	99300/124550= 0.79727

Now, by multiplying cost per driver with each activity measure we get the manufacturing cost per unit of both the products

Manufacturing cost per activity = Cost per driver * Activity measure

For example:

For purchasing cost, cost per activity driver = 30

For purchasing activity measure = No of orders

From the above data no of orders of standard (From table 1) = 140

So, purchasing cost for standard product = 30*140 = 4200

In the same way, we calculate for both the products.

Table 3

Particulars	Cost per activity driver (I) from table 2	Standard (B) from table 1                      Cost	Speciality (C) from table 1                        Cost	Total cost both the products should match with activity cost
Purchasing	30	140	30*140= 4200	190	30*190= 5700	4200+5700= 9900
Material handling	60	145	60*145 = 8700	275	60*275= 16500	25200
Production orders and setups	120	20	120*20= 2400	70	120*70= 8400	10800
Inspection	32.8	280	32.8*280= 9184	370	32.8*370= 12136	21320
Frame assembly	10	630	10*630= 6300	730	10*730= 7300	13600
Machine related	0.79727	120000	120000*0.79727= 95672	4550	4550*0.79727= 3628	99300
Total manufacturing cost			126456		53664

So from the above data we found out manufacturing cost as per ABC costing is

For Standard = 126456

For Speciality = 53664

Now we will try to answer the questions given.

1) Manufacturing overhead cost per unit as per ABC costing

Manufacturing overhead cost per unit = Total manufacturing cost/ Total units

For standard = 126456/20000 = 6.32

For Speciality = 53664/3500 = 15.33

2) Unit cost of each product as per ABC costing

Particulars	Standard (In $)	Speciality (In $)
Total material cost	8.6	18.8
Direct labour	5.65	4.52
Manufacturing cost	6.32 (From answer 1)	15.33 (from answer 1)
Total unit cost	8.6+5.65+6.32= 20.57	38.65

3) Gross margin (loss) per unit

Particulars	Standard (In $)	Speciality (In $)
Selling price per unit	24.15	41.8
Total unit cost	20.57	38.65
Gross margin as per ABC	3.58	3.15
Gross margin as per traditional	2.00	12.16
Change in margin	3.58-2 = 1.58 margin increased as per ABC	3.15-12.16 = 9.01 margin decreased as per ABC

So, as per ABC costing we can conclude that standard briefcases are more profitable products than speciality products.