Question

Jeri Cooper, the sales manager of Brunners Corporation, is getting worried. Her last three bids were rejected in favor of a lower bid from a new competitor to the market. Now, she is putting together a bid for a potential new customer, and she wants to make sure the price is competitive, but still profitable. As the managerial accountant at Brunners, your job is to help Jeri prepare bids by providing the most accurate cost estimates.

Brunners is a plastic injection custom molding company, which advertises its highly automated process as keeping costs low. Currently, Brunners uses a traditional (plantwide) costing system, with overhead costs allocated based on total direct labor hours. Brunners expects to use a total of 95,000 direct labor hours this year. Suspecting that their traditional costing system is partially to blame for their recent problems, Brunners has begun the process of implementing ABC. However, before this new company entered the market, Brunners had little need to review their processes. Jeri has very little understanding of cost accounting, and has asked if her recent unsuccessful bids were due to an inaccurate costing system, or if there are process inefficiencies that have driven up costs.

In the ABC implementation process, Brunners Corporation has identified four activities. The ‘production’ activity is a highly automated process, where a few workers oversee several machines as they produce parts. This is a large cost pool, as it includes the depreciation on the building and all the plastic injection molding machines (i.e., millions of dollars of property, plant, and equipment), and the wages of these production employees is directly traced to the job. In the ‘materials’ activity, workers with specialized machine training prepare each machine for a new process or color (setups) by cleaning and changing the molds in the machines, and then refilling the machines with plastic pellets (refills) as needed. Wages of these workers is considered indirect labor. In the ‘correction’ process, workers trim extra plastic from the parts. This extra plastic normally snaps off cleanly as the parts come out of the mold, but often needs to be trimmed as the molds get worn or if the mold is not correctly installed in the machine. Wages of these workers is also directly traced to the job. The trimming process is also where parts that are defective are thrown out, so this activity also includes the cost of wasted materials. Finally, in the ‘inspection’ activity, inspectors randomly select and inspect parts to ensure compliance with the customer’s specifications. Inspectors’ wages are considered indirect labor.

Having determined four activities used at Brunners, the ABC implementation team has separated the plant’s total overhead costs into the activity cost pools (see Table 1). The next step in the ABC implementation process it to identify cost drivers for each activity. So far, they have identified cost drivers for each of the activities (see Table 1). This is still a work in progress, though, and they are still making adjustments.

The proposed job is somewhat different, requiring pieces in a variety of colors (see Table 2 for details on the proposed job). Historically, customer jobs have required only one or two setups. While Brunners has not needed to support these types of requests in the past, several recent bids (all rejected) have had similar needs. The plant manager believes that these types of jobs will increase in the future. Proving that they can support these requests may result in new business in the future.

You’ve realized that you could provide value to Brunners in a several different ways. First, providing cost estimates from both the traditional process and the proposed ABC method could shed some light on the accuracy of the cost estimation process. Second, you can use activity based management to identify improvements that could be made to the production process (if any). Finally, with your knowledge of this job (and the market looking forward), you could provide some valuable input to the ABC implementation team.

Table 1: ABC activities, cost drivers, and cost pools

Activity	Activity cost driver	Total activity cost pool	Est. cost driver usage
Production	Machine hours	$1,580,000	600,000
Materials	Lbs of materials	$620,000	230,000
Correction	DLH (trimming)	$755,000	35,000
Inspection	# of inspections	$290,000	2,000

Table 2: Job proposal (resources)

Direct materials	$7,400
Direct labor (total cost)	$11,600
Direct labor hours (in production)	250
Direct labor hours (in correction)	575
Lbs of material	3,500
Number of setups	6
Number of colors used	4
Number of inspections	15
Number of machine-hours	1000

Required:

Write a 1-2 page memo, as the accountant of Brunners Corp, addressed to Jeri Cooper describing your analysis and the outcomes. Make sure you respond to the following items:

1.   Provide a total cost estimate using the current traditional costing system.

2.   Provide a total cost estimate using the activity based costing system proposed by the ABC implementation team.

3.   Explain to Jeri which cost estimate should be used to develop her bid, and why.

4.   Use activity based management to respond to Jeri’s question about process inefficiencies driving up costs.

5.   Evaluate the ABC system as it currently stands. Explain what specific change(s) you recommend the ABC implementation team make, and how that could affect your cost estimates.

Answer 1

1.   Provide a total cost estimate using the current traditional costing system.

Working as follows:

Production	$1,580,000
Material	$620,000
Correction	$755,000
Inspection	$290,000
Total Overhead costs	$3,245,000

Pre-determined overhead rate = Total overhead cost   Total Direct Labor Hours

= $3,245,000 95,000 labor hours

= $34.16 direct labor hours

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Compute Cost Estimate Under Traditional Costing:

Particulars	Amount
Direct Materials	$7,400
Direct Labor	$11,600
Overheads [$34.16 × [250+575] hours	$28,182
Total Cost Estimate of the Job	$47,182

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2.   Provide a total cost estimate using the activity based costing system proposed by the ABC implementation team.

Compute Activity rate as follows:

_________________________________________________

Overhead Allocation Statement as follows:

	Working	Amount
Production	[1000 machne hours × $2.63]	$2,630
Materials	[3,500 lbs × $2.70]	$9,450
Correction	[575 DLH × $21.57]	$12,403
Inspection	[15 Inspection × $145]	$2,715
Total Overhead		$27,198

Cost Estimate Under ABC Costing as follows:

Particulars	Amount
Direct Materials	$7,400
Direct Labor	$11,600
Overheads	$27,198
Total Cost Estimate of the Job	$46,198

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3.

The traditional costing method allocates overhead without respecting the complexity of the job and allocates uniformly to all jobs, while ABC distributes the overhead cost in proportion to the actual activities performed with respect to the specific job.