Question

In this assignment, you will play the role of a senior analyst.

You work for Blackhawk Company, a lighting fixture manufacturer.

Upper management at Blackhawk is concerned with the traditional costing system it has relied on for the past few years. In particular, upper management is concerned about the accuracy of cost information and thus has ordered a “pilot” test of an activity-based costing approach.

You will receive an analysis prepared by your junior staff. Your task is to interpret the analysis, and communicate related implications and other considerations.

Note: Please read all of the provided information, including the required deliverables, before beginning the assignment.

Case Information

Use the information provided here to answer the questions.

Blackhawk Company manufactures and sells many different types of lighting fixtures.

Historically, indirect costs have been allocated to products based on direct labor dollars, via a traditional costing system. The overhead rate is pre-determined, based on budgeted volumes and budgeted direct labor.

For the upcoming year, Blackhawk compiled the following projected per-unit information for its deluxe model – one of many products that Blackhawk produces and sells.

Product Information (Traditional Costing System)

Selling price $900

Direct materials $250

Direct labor $120

Indirect costs $340

Profit per unit $190

The CFO has suggested that an activity-based costing system could be valuable to help facilitate strategic and operational decisions for the coming year. She ordered a pilot test of the activity-based costing system using the deluxe product.

Your staff obtained the following information to compute an activity-based version of the deluxe product’s cost.

Note: These totals are company-wide (i.e., not just for the deluxe model).

Activity	Cost Driver	Cost	Total
Setups	# batches	$500,000	725 batches
Machine-related	# of machine-hours	$44,100,000	650,000 MHs
Packing	# of shipments	$5,000,000	250,000 shipments

In addition, the following information is known for the deluxe model.

Number of units per batch = 125

Number of machine hours per unit = 10

Number of units per shipment = 1

Analysis

A junior staff member provided the following analysis.

Activity Pool Rates

Setups: $500,000 / 725 batches = $689.66 per batch

Machine time: $44,100,000 / 650,000 machine hrs = $67.85 per machine hr

Packing: $5,000,000 / 250,000 shipments = $20 per shipment

Using the activity pool rates and the estimated usage of each activity by the deluxe model, the junior analyst provided the following cost estimate on a per unit basis:

Setups: $689.66 per batch / (125 units per batch) = $5.52 per unit

Machine time: $67.85 per machine hour x 10 machine hours per unit = $678.50 per unit

Packing: $20 per shipment / (1 unit per shipment) = $20 per unit

Total per unit cost = $5.52 + $678.50 + $20 = 704.02

The analyst also provided the revised profit per unit information:

Selling price = $900

Revised costs (rounded) (per activity-based costing) = $704

Profit per unit = $900 - 704 = $196

The analyst noted that the per-unit cost, as well as the profit per unit were approximately equivalent across the two systems (i.e., the original/traditional system and the activity-based costing system).

Given this small difference, the analyst concluded that the original system is reasonably accurate, and that activity-based costing may not be worthwhile for Blackhawk Company.

Question 1:

Write a critique of the analysis and conclusion prepared by your analyst.

In particular, is the analyst’s conclusion (i.e., that activity-based costing is not worthwhile for Blackhawk Company) correct?

Question 2:

Prepare a memo to Blackhawk’s upper management regarding the advantages and disadvantages of activity-based costing.

Use an example scenario to communicate the advantages and disadvantages.

Answer 1

Activity Based Costing (ABC) is the allocation of indirect cost to products based on the activities that are involved in producing the product unlike traditional costing system where the indirect costs are allocated based on the proportion of direct labor or machine hours.

In ABC method the total costs are pooled under buckets based on activities i.e. setups, machine related and packages in this question. We have to analyse the cost drivers for each activity which are mentioned in the question for e.g. the cost driver for Packaging is number of shipments. The costs are computed as below:

In the analysis made by the junior staff, the staff has considered only the indirect cost in arriving at the total unit cost. Whereas, the direct material and labor costs are not considered. The computation would be as follows:

Hence the company would report a loss for Deluxe model when using the ABC method.

Advantages of ABC Method:

• ABC method is useful when the company produces more than one product as the allocation of indirect costs to products will be based only on the activities involved in producing the product.
• A true picture and understanding of the costs absorbed by each product can be identified.
• For e.g. In the given question the major portion of indirect cost is machine hours. This can be due to inefficient production methods. The company can take up studies to analyse the machine hours and machine related cost. Say the costs can be high due to higher maintenance cost as the machinery used may be old.

Disadvantages of ABC Costing:

• ABC method is not useful when the activities are labor or machine intensive as the costs can be allocated based on labor or machine hours.
• There are many challenges involved like the management must be able to provide accurate data for the analysis and it can be difficult to gather data.
• This system can turn out to be expensive to maintain.