Question

Franklin Fireplace Inserts manufactures two premium models of fireplace inserts that provide more BTUs of heat per cord of wood than any other wood burning fireplace insert or stove. One model, the Heatilator, sells for $1,800, and the Heat Queen, a new model that sells for $1,200. Franklin’s marketing department suggested that the company should concentrate on the new Heat Queen model and begin to phase out the Heatilator model.

            Franklin currently uses a traditional costing system. The following cost information has been used as a basis for pricing decisions over the past year.

Per-Unit Data                          Heatilator          Heat Queen

Direct materials                           $200                 $280

Direct labor hours                           1.5                    1.5

Machine hours                                5.0                    4.0

Units produced                         11,000                4,000

            Direct labor cost is $20 per hour, and the machine usage cost is $18 per hour. Manufacturing overhead costs were estimated at $4,800,000 and were allocated on the basis of machine hours.

            Gwen Freely, the new company controller, suggested that an activity-based costing analysis first be performed to obtain a better picture of the true manufacturing cost. The following data were collected:

Activity Center            Cost Driver                              Traceable Costs

Soldering                     Number of solder joints                 $   942,000

Shipments                    Number of shipments                         860,000

Quality control             Number of inspections                     1,240,000

Purchase orders           Number of orders                               950,400

Machining                    Machine hours                                      57,600

Machine setups            Number of setups                               750,000

Total traceable costs                                                           $4,800,000

            Number of Events during the year:

Activity                                Heatilator        Heat Queen           Total

Soldering                               296,250              96,250           392,500

Shipments                                  4,050                   950               5,000

Quality control                        14,050                5,325             19,375

Purchase orders                       20,025              27,495             47,520

Machining                               44,000                4,000             48,000

Machine setups                          4,000                3,500               7,500

            Selling, general, and administrative costs per unit sold are $175.00 for Heatilator and $125 for Heat Queen.

a.   Calculate the manufacturing cost per unit for Heatilator and Heat Queen under:

1.   A traditional costing system

2.   The ABC system

b.   Explain the differences in manufacturing cost per unit calculated in part (A).

c.   Which system would most likely do a better job of measuring costs for this product emphasis/keep or drop decision? Explain.

d.   Franklin’s controller points out that the ABC information could also be used to identify and eliminate non-value added activities. Explain how ABC and ABM can be used for this purpose.

Answer 1

Answer a)
1
	Cost Type	Heatilator	Heat Queen
	Direct materials	200.00	280.00
	Direct labors	30.00	30.00
	Machine usage cost	90.00	72.00
	Manufacturing overhead cost	338.03	270.42
	Total manufacturing cost	658.03	652.42
	Working
	Total manufacturing overhead cost	4,800,000.00
	Total machine hours	71,000.00	(11000x5 + 4000x4)
	Overhead allocation rate per machine hour	67.61
Answer a)
2
	Cost Type	Heatilator	Heat Queen
	Direct materials	200.00	280.00
	Direct labors	30.00	30.00
	Machine usage cost	90.00	72.00
	Manufacturing overhead cost	287.28	409.98
	Total manufacturing cost	607.28	791.98
	Working
					Number of Activity		Cost Allocation based on Cost Per Activity
	Activity Center	Traceable Costs	Activity Total	Cost per Activity	Heatilator	Heat Queen	Heatilator	Heat Queen
	Soldering	942,000.00	392,500.00	2.40	296,250.00	96,250.00	711,000.00	231,000.00
	Shipments	860,000.00	5,000.00	172.00	4,050.00	950.00	696,600.00	163,400.00
	Quality control	1,240,000.00	19,375.00	64.00	14,050.00	5,325.00	899,200.00	340,800.00
	Purchase orders	950,400.00	47,520.00	20.00	20,025.00	27,495.00	400,500.00	549,900.00
	Machining	57,600.00	48,000.00	1.20	44,000.00	4,000.00	52,800.00	4,800.00
	Machine setups	750,000.00	7,500.00	100.00	4,000.00	3,500.00	400,000.00	350,000.00
		4,800,000.00					3,160,100.00	1,639,900.00
	Total Number Units Produced						11,000.00	4,000.00
	Manufacturing Overhead cost per unit						287.28	409.98
Answer b)
	As per both Traditional & Activity based costing system, there will be no difference in the direct cost such as direct material, direct labor cost because these cost are directly identifiable & attributable to each unit
	Under traditional cost, the manufacturing overhead cost is allocated based on machine hours, whereby Module-Heatiltor bears the cost of 658 as compared to Heat Queen of 652. However ABC method of costing accurately captures the costing, which reveals that Module-Heatilator consumes only 287 as compared to Heat Queen of 410
Answer c)
	Activity-based costing is a way to apportion costs based on the amount of resources a product or service consumes.
	The use of ABC is particularly necessary to businesses that provide tailored products or services.
	A tailored production atmosphere requires ABC’s allocation of actual indirect costs to a product to categorize its true cost.
	Therefore in this setup, The usage of ABC method benefit the organization better pricing, cost controlling and etc.
Answer d)
	Activity-based management (ABM) can be defined as the entire set of activities that can be taken on a better informed basis using ABC information. The purpose is to attain the same level of output with lower costs.
	Stages in ABC & ABM
	1.      Identify the activities that the organization performs
	2.      Calculate the cost of each activity
	3.      Identify the activity cost driver for each activity.
	The purpose and stages of ABC & ABM focuses on identifying and eliminating the activities that don’t add value. Also under this system each cost and its relationship to main cost and activity driver is better analyzed, therefore any wastage or improvement can be quickly identified.