Question

Beaver Co. is a publicly-traded corporation that produces different types of air fryers. My name is Alan Smith and I have worked for this company for the last ten years in the controller’s office. I was both an accounting and finance major at university. The company currently produces 300 products and does not anticipate any new products coming out over the next three years. I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional costing system (where overhead costs are allocated across products at a rate of $30 per direct labor hour) when different products require different amounts of indirect overhead resources. For example, under the traditional system, all costs associated with the testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor hours. Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor hours. Given that traditional costing systems may result in significant cost distortions when determining product costs and given that the firm now has revenues of over $100 million a year, Beaver has decided to adopt activity-based costing over the next year or two. Further, Classic is sold in large quantities whereas Artisan is sold in small quantities.

Current information from our existing system on a per unit basis is shown in Exhibit 1.

Exhibit 1

	Classic	Artisan
Direct material	$20	$40
Direct labor hours	1.5	2
Direct labor wage rate per hour	$15	$15
Sales price per unit	$100	$150

My staff has identified for Deloitte five activity cost pools. Information on those cost pools and the related activity measures are provided in Exhibit 2.

Exhibit 2

	Total Costs	Allocation Base	Level of Allocation Base
Equipment setups	$4,000,000	number of setups	50,000
Purchase orders	$2,000,000	number of purchase orders	20,000
Machining	$5,000,000	number of machine hours	80,000
Testing	$7,000,000	number of testing hours	250,000
Packaging and shipping	$6,000,000	number of containers	300,000

Although fixed costs are lumped in with variable costs across the five different cost pools, I am aware that machining related costs consist almost exclusively of depreciation costs. Hence, with respect to all questions asked in this case, machining costs will be treated as entirely fixed with respect to machine hours. Each machine is used in the production of multiple product lines. The resale value of machines is only affected by the passage of time and not by how much they are used in a given year. In all questions asked in this case, the firm will assume that costs associated with equipment setups, purchase orders, testing, and packaging & shipping are variable with respect to their respective activity measures. Currently, we believe our assumptions on cost behavior patterns are quite reasonable. All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors.Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the firm never has a beginning or ending work in process inventory, and it does not have a beginning or ending finished goods inventory.

Further information on our two products is provided in Exhibit 3

Exhibit 3

	Classic	Artisan
annual sales and production in units	500,000	80,000
number of units per batch	400	50
number of purchase orders	500	320
number of machine-hours per unit	0.6	1
total number of testing hours	30,000	50,000
total number of containers	1,200	4,000

REQUIRED:

1. (20 Points) Calculate product margin for Classic and Artisan using the traditional costing system where overhead is applied at a rate of $30 per direct labor hour. The amount of product margin should be on a total basis and then show the average product margin unit using the following template for guidance:

                                                    Classic                                 Artisan

Sales                                                    $$$                                          $$$     

Direct materials                          $$$                                           $$$            

Direct labor                                 $$$                                           $$$            

Manufacturing overhead             $$$                                           $$$            

Cost of goods sold                              $$$                                          $$$                 

Product margin                                   $$$                                          $$$                 

Average product margin per unit       $$$                                          $$$

Answer 1

	Classic	Artisan
Direct Material	20	40
Direct Labour Hours	1.5	2
Wage Rate	15	15
Sales Price Per Unit	100	150
Cost Drivers	Total Costs	Allocation Base	Level of Allocation Base	Cost Per Unit Of Driver
Equipment setups	40,00,000	number of setups	50,000	80
Purchase orders	20,00,000	number of purchase orders	20,000	100
Machining	50,00,000	number of machine hours	80,000	62.5
Testing	70,00,000	number of testing hours	2,50,000	28
Packaging and shipping	60,00,000	number of containers	3,00,000	20
Statement of Cost
Particulars	Classic	Artisan	Cost Per Unit Of Driver	Classic	Artisan
annual sales and production in units	5,00,000.00	80,000.00
number of units per batch	400.00	50.00
No. Of Batches Set Up	1,250.00	1,600.00	80.00	1,00,000.00	1,28,000.00
number of purchase orders	500.00	320.00	100.00	50,000.00	32,000.00
number of machine-hours per unit	0.60	1.00
Total No. Of Machine Hrs	3,00,000.00	80,000.00	62.50	1,87,50,000.00	50,00,000.00
total number of testing hours	30,000.00	50,000.00	28.00	8,40,000.00	14,00,000.00
total number of containers	1,200.00	4,000.00	20.00	24,000.00	80,000.00
				1,97,64,000	66,40,000
As per Traditional Approach
Particulars	Classic	Artisan
Sales	5,00,00,000	1,20,00,000
Direct Material	1,00,00,000	32,00,000
Direct Labour	1,12,50,000	24,00,000
Manufacturing Overhead @ Rs 30 per Labour Hour	2,25,00,000	48,00,000
Cost of Goods Sold	4,37,50,000	1,04,00,000
Product Margin	62,50,000	16,00,000
Average Product Margin Per Unit	12.5	20
As per Activity Based Approach
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