In: Accounting
Hydraulic Hoses, Inc. produces specialized industrial hoses for application such as high-pressure hydraulics and the transference of highly corrosive materials. The company recently implemented and ABC system for three of its products and is interested in evaluating its effectiveness before converting to an ABC system for thress of its products and is interested in evaulating its effectiveness before converting to an ABC system for all of its products. To perform this evaluation the company has compiled data for the three products using both the traditional system and the new ABC syste. The traditional system uses a single driver (direct materials costs). The ABC system uses a variety of cost drivers related to the activities used to produce the metal products. The three products involved in the trial run of the ABC system were D-13, K-17, and R-23. The following data relate to these products.
Product Selling Price Per Unit Units produced Total Costs Allocated Traditonal Costing Cost per Unit Traditonal Costing Total Cost allocated ABC Cost per Unit ABC
D-13 $14.65 250,000 $2,100,000 $8.40 $2,000,000 $8.00
K-17 15.60 140,000 1,280,000 9.14 1,235,000 8.82
R-23 18.50 20,000 1,214,500 10.73 369,500 17.98
Total 3,594,500 3,594,500
Required
a) Determine the gross profit margin for each product produced based on the ABC data[(Selling price - ABC cost per) x Unit produced].
b) Determine the gross profit margin for each product produced based on the traditional costing data [(Selling price - Tradtional cost per unit) x Unit produced].
c) Provide a possible explanation as to why the cost of R-23 increased under the ABC system while the cost D-13 decreased.
d) Suggest what action management might ask with repsect to the discoveries resulting from the ABC versus traditional costing analysis. Assume that Hydraulic Hoses expects to produce a gross profit margin on each product of at least 40 percent of the selling price.
(a) ABC Costing
Products |
SP per unit |
ABC cost per unit |
Units Produced |
Gross Profit |
D-13 |
14.65 |
8 |
250000 |
1662500 |
K-17 |
15.60 |
8.82 |
140000 |
949200 |
R-23 |
18.50 |
17.98 |
20000 |
10400 |
(b) Traditional costing :-
Products |
SP per unit |
Traditional cost per unit |
Units Produced |
Gross Profit |
D-13 |
14.65 |
8.40 |
250000 |
1562500 |
K-17 |
15.60 |
9.14 |
140000 |
904000 |
R-23 |
18.50 |
10.73 |
20000 |
155400 |
(c) Overhead cost have increased so much that direct labor is no longer considered a direct cost. This changes the way that cost must be allocated. Using the ABC system a company must use a two stage process in allocating the amount of cost in which they first allocated the cost to certain cost pools and then they are allocated into separate cost drivers/jobs. This could be the reason why the cost increased in the one product line and decreased in the other since under the traditional system the cost would have been put with the product line and under the ABC system the costs are divided up by the two stage process which could allow for direct labor to be ignored and placed in the cost pools that are then put into a different cost driver/jobs than under the traditional method. The costs according to the ABC system the overhead costs are allocated to a cost pool based on the amount of times used such as the time raw materials are purchased or machine hours, drivers, etc. Therefore it would stand to reason that if the product line for R-23 has increased and the D-13 has decreased under the ABC system then the overhead costs including the machine hours to produce each product line would be allocated along with other costs that were placed into a certain cost pool then placed into the appropriate cost driver/job.