Question

Manufacturing overhead	Amount	Cost driver	Standard Guest Room	Junior Suite	Presidential Suite
						Depreciation	$3,200,000	Square feet	50,000	30,000	30,000
Maintenance	$1,800,000	Direct labor hours	180,000	143,000	148,500
						Purchasing	$320,000	# of purchase orders	2,500	1,500	9,000
												Inspection	$850,000	# of inspections	1,000	850	3,500
Indirect	$490,000	Units manufactured	150	110	25
materials
Supervision	$1,700,000	# of inspections	1,000	850	3.5
Supplies	$190,000	Units manufactured	150	110	25

6. Why are the costs different between the traditional method and the activity-based method?

7. At the current selling price, is the company covering its true cost of production of the Presidential Suite? Briefly discuss.

8. What should price should Choice Hotels charges for the Presidential Suite?

9. Assume that the Presidential Suite has the same profit margin as the Standard Guest Room. What should its selling price be? Show all calculations.

10. What should Choice Hotels do if the quantity of the Presidential Suite Guest Rooms sold at the new price falls to 10 per year?

11. What should Choice Hotels do if the price of the Presidential Suite cannot exceed $1,050,000?

12. At a selling price of $1,050,000 each, what is the breakeven unit volume for the Presidential Suite?

13. What are the lessons learned from this case?

Answer 1

6. In traditional method a single rate is applied to total overhead costs of a manufacturing unit or a manufacturing division or a cost center. The rate may be based on direct labor hour/machine hour / unit of output etc.

Using traditional methods, Overhead costs to Standard Guest Room, Junior suit and Presidential suits would have been allocated using a single rate of Dollar per direct labor hour

Under the activity based costing method, costs are allocated to activity cost pools (like purchasing, inspection, maintenance etc) based on the cost driver which may be different for different activity. Overheads are allocated to products   based on the resources consumed.

Activity Cost Pool	Cost Driver
Maintenance	Direct Labor hour
Depreciation	Square feet
purchasing	# of purchase order
Inspection	# of inspection
Indirect materials	Units manufactured
Supervision	# of inspection
Supplies	Units manufactured

Instead of one rate, seven rates are used to allocated overhead costs to products based on activity level or resources consumed

Activity based costing reflects more accurate cost allocation

7. Cost of Presidential   suite:

Activity Cost Pool	Total Cost	Allocated to Presidential Suite	Calculation
Maintenance	$1,800,000	$       566,914	(1800000/(180000+143000+148500))*148500
Depreciation	$3,200,000	$       872,727	(3200000/(50000+30000+30000))*30000
purchasing	$320,000	$       221,538	(320000/(2500+1500+9000))*9000
Inspection	$850,000	$            1,605	(850000/(1000+850+3.5))*3.5
Indirect materials	$490,000	$          42,982	(490000/(150+110+25))*25
Supervision	$1,700,000	$            3,210	(1700000/(1000+850+3.5))*3.5
Supplies	$190,000	$          16,667	(190000/(150+110+25))*25
TOTAL	$8,550,000	$1,725,644

Units manufactured=25

Cost per unit manufactured=1725644/25=$69,026

Amount to be charged =Cost +Profit percentage

Assuming 30% on cost;

Price to be charged=69026*1.3=$89,733