Question

ABC Versus ABM

Harvey Company produces two models of blenders: the “Super Model” (priced at $405) and the “Special Model” (priced at $202). 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 $182, 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	$5,412,000	90,200 machine hours
Inspection	3,739,200	45,600 inspection hours
Rework	1,828,000	45,700 rework hours

The consumption patterns of the two products are as follows:

	Special	Super
Units	100,000	27,800
Machine hours	48,400	41,800
Inspection hours	10,000	35,600
Rework hours	7,700	38,000

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.
$ 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.
$ 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.
$ per unit

Comment on the difference between ABC and ABM.

Answer 1