Question

1. ABC Versus ABM

   Harvey Company produces two models of blenders: the “Super Model” (priced at $399) and the “Special Model” (priced at $201). Recently, Harvey has been losing market share with its Special Model because of competitors offering blenders with the same quality and features but at a lower price. A careful market study revealed that if Harvey could reduce the price of its Special Model to $181, it would regain its former share of the market. Management, however, is convinced that any price reduction must be accompanied by a cost reduction of the same amount so that per-unit profitability is not affected. Earl Wise, company controller, has indicated that poor overhead costing assignments may be distorting management’s view of each product’s cost and, therefore, the ability to know how to set selling prices. Earl has identified the following overhead activities: machining, inspection, and rework. The three activities, their costs, and practical capacities are as follows:

   Activity	Cost	Practical Capacity
   Machining	$5,310,000	88,500 machine hours
   Inspection	3,393,000	43,500 inspection hours
   Rework	1,822,800	43,400 rework hours

   The consumption patterns of the two products are as follows:

   	Special	Super
   Units	100,000	30,200
   Machine hours	49,500	39,000
   Inspection hours	9,200	34,300
   Rework hours	7,000	36,400

   Harvey assigns overhead costs to the two products using a plantwide rate based on machine hours.

   Required:

   1. Calculate the unit overhead cost of the Special Model using machine hours to assign overhead costs. Round intermediate calculations and your final answer to the nearest cent, if rounding is required.
   $fill in the blank 1 per unit

   Now, repeat the calculation using ABC to assign overhead costs. Round intermediate calculations and your final answer to the nearest cent, if rounding is required.
   $fill in the blank 2 per unit

   Did improving the accuracy of cost assignments solve Harvey’s competitive problem?

   2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higher-quality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Round intermediate calculations and your final answer to the nearest cent, if rounding is required.
   $fill in the blank 4 per unit

   Comment on the difference between ABC and ABM.

Answer 1

I
	A	Machining	5,310,000
	B	Inspection	3,393,000
	C	Rework	1,822,800
	D	Total Overhead(A+B+C)	10,525,800
	E	Total Machine Hours	88,500
	F=D/E	Overhead Per Machine Hour	118.9	(10525800/88500)
	G	Machine Hours-Special Model	49,500.0
	H=G X F	Overhead allocated to Special Model	5,887,311.9	(49500 X118.94)
	I	Special Model Units	100,000.0
	J=H/I	Per Unit Overhead	58.9
		ABC Analysis
			Activity Rate	Activity Used	Allocation
		Machining	(5310000/88500)=60	49500	2,970,000	(49500 X 60)
		Inspection	(3393000/43500)=78	9200	717,600	(9200 X78)
		rework	(1822800/43400)=42	7000	294,000	(7000 X 42)
				Total	3,981,600
		Rate Per Unit	39.82	(3981600/100000)
		Yes-Improve the accuracy of cost assignments solve Harvey’s competitive problem . As cost is reduced from 58.9 to 39.82
II
			Activity Rate	Activity Used	Allocation
		Machining	60	49500	2,970,000	(49500 X 60)
		Inspection	39	9200	358,800	(9200 X39)
			(78 X 50%)
		rework	21	7000	147,000	(7000 X 21)
			(42 x50%)
				Total	3,475,800
		Cost Per Unit	34.76	(3475800/100000)
		Due to high quality component,price is further reduced from39.82 to 34.76 , resulting in net benefit of5.06(39.82-34.76) per unit