Question

Peach Bags​ (PB) is a designer of​ high-quality backpacks and purses. Each design is made in small batches. Each​ spring, PB comes out with new designs for the backpack and for the purse. The company uses these designs for a year and then moves on to the next trend. The bags are all made on the same fabrication equipment that is expected to operate at capacity. The equipment must be switched over to a new design and set up to prepare for the production of each new batch of products. When​ completed, each batch of products is immediately shipped to a wholesaler. Shipping costs vary with the number of shipments. Budgeted information for the year is as​ follows:

Peach Bags
Budget for Costs and Activities
For the Year Ended February 28, 2014
Direct materials—purses			$323,200
Direct materials—backpacks			456,000
Direct manufacturing labor—purses			102,400
Direct manufacturing labor—backpacks			99,000
Setup			17,000
Shipping			73,000
Design			166,000
Plant utilities and administration			212,000
Total			$1,448,600
Other budget information follows:
	Backpacks	Purses	Total
Number of bags	6,000	3,200	9,200
Hours of production	1,500	2,500	4,000
Number of batches	120	80	200
Number of designs	2	2	4

1.

Identify the cost hierarchy level for each cost category.

2.

Identify the most appropriate cost driver for each cost category. Explain briefly your choice of cost driver.

3.

Calculate the budgeted cost per unit of cost driver for each cost category.

4.

Calculate the budgeted total costs and cost per unit for each product line.

5.

Explain how you could use the information in requirement 4 to reduce costs.

Answer 1

Answer:

1

Direct materials—purses	Output unit-level costs
Direct materials—backpacks	Output unit-level costs
Direct manufacturing labor—purses	Output unit-level costs
Direct manufacturing labor—backpacks	Output unit-level costs
Setup	Batch-level costs
Shipping	Batch-level costs
Design	Product-sustaining costs
Plant utilities and administration	Facility-sustaining costs

2

Direct materials—purses	Number of purses
Direct materials—backpacks	Number of backpacks
Direct manufacturing labor—purses	Number of purses
Direct manufacturing labor—backpacks	Number of backpacks
Setup	Number of batches
Shipping	Number of batches
Design	Number of designs
Plant utilities and administration	Hours of production

Direct material and direct manufacturing labor are costs that can be easily traced to output, which in this case is the number of purses or backpacks produced. Setup and shipping are both a function of the number of batches produced.

Design is related to the number of designs created for each product.

Plant utilities and administration result from general activity level in the plant. Thus, hours of production seems to be an appropriate cost driver.

3

Direct materials—purses	$323,200 ÷ 3200 purses = $101 per purse
Direct materials—backpacks	$456,000 ÷ 6,000 backpacks = $76 per backpack
Direct manufacturing labor—purses	$102,400 ÷ 3200 purses = $32.0 per purse
Direct manufacturing labor—backpacks	$99,000 ÷ 6,000 backpacks = $16.50 per backpack
Setup	$17,000 ¸ 200 batches = $85 per batch
Shipping	$73,000 ¸ 200 batches = $365 per batch
Design	$166,000 ÷ 4 designs = $41,500 per design
Plant utilities and administration	$212,000 ÷ 4,000 hours = $53 per hour

4

	Backpacks	Purses	Total
Direct materials	$456,000	$323,200	$779,200
Direct manufacturing labor	99,000	102,400	$201,400
Setup       ($85 × 120; 80 batches)	10,200	6,800	$17,000
Shipping ($365 × 120; 80 batches)	43,800	29,200	$73,000
Design     ($41.500 × 2; 2 designs)	83,000	83,000	$166,000
Plant utilities and administration	79,500	132,500	$212,000
($53 × 1,500; 2,500 hours)
Budgeted total costs	$771,500	$677,100	$1,448,600
Divided by number of backpacks/purses	÷ 6,000	÷ 3,200
Budgeted cost per backpack/purse	$128.58	$211.59

5

As we can see that, more than 50% of the product cost related to the direct material. So managers must determine whether they can reduced the cost of direct material . if they produce in small lots then it will increases cost like setup and the shipping costs but we can see that they are relatively small components of the product cost, management should evaluate ways for reducing number of setups and cost per setup. from indirect costs, we can see that product- and facility-sustaining costs are the highest. Management must review the design process for savings the cost and they should examine why it takes so long to produce purses relative to backpacks.