Activity-Based Costing; Customer Group Cost Analysis Lenngton Furniture, Inc. (LFI) manufactures bedroom furniture in sets (a set includes a dresser, two queen-size beds, and one bedside table) for use in motels and hotels. LFI 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 low-cost 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. LFI 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. LFI has used a volume- based rate based on direct labor-hours for some time. Direct labor cost is $12 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 |
|
The budgeted production data for the three product lines follows.
Product Lines | Value | Quality | Luxury |
Units produced | 15,000 | 5,000 | 500 |
Price | $ 650 | $ 900 | $1,200 |
Direct materials cost per unit | $ 80 | $ 50 | $ 110 |
Number of parts per unit | 30 | 50 | 120 |
Direct labor-hours per unit | 4 | 5 | 7 |
Machine-hours per unit | 3 | 7 | 15 |
Production orders | 50 | 70 | 200 |
Production setups | 20 | 50 | 50 |
Orders shipped | 1,000 | 2,000 | 300 |
Number of inspections | 2 | 6 | 14 |
Required
1. Determine the cost per set and the total production cost of each of the three customer groups using activity-based costing.
2. Determine the production cost for each of the three customer groups using LFI’s current volume-based approach.
3. The activity usage data given in the problem reflects current usage of the various cost drivers to manufacture the firm’s product lines. Suppose you are given the following information regarding the firm’s practical capacity for each of these activities, as follows:
Cost Driver | Practical Capacity |
Number of parts | 990,000 |
Number of production orders | 800 |
Number of setups | 200 |
Machine-hours | 100,000 |
Direct labor-hours | 123,900 |
Number of orders shipped | 5,000 |
Comment on how you would use this additional information for costing the firm’s products and assisting in strategic planning.
4. Compare the two approaches and discuss the strategic and competitive issues of using each of the two methods.
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