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In: Accounting

Handout Question 1: Stokes Bay Fishing Corporation manufactures and sells fishing boats. The CEO of the...

Handout Question 1:

Stokes Bay Fishing Corporation manufactures and sells fishing boats. The CEO of the company, Keith Jones, has been fishing since he was a young boy and is very excited to be the majority owner of a successful fishing-related business. All of the company’s sales come from two products: the Fish Hauler and the Trolling Deluxe. Both are 16-foot aluminum boats. The Fish Hauler is a basic boat built with the minimum required components necessary for a successful outing and sells for $12,000. The Trolling Deluxe sells for $14,500 and is built for the luxury-minded outdoors person; it includes adjustable padded seats, moveable storage boxes, and rod holders, among other conveniences, to make the trip more comfortable. The boats are sold to retailers who then usually add an outboard motor and a trailer before selling to the consumer.

Stokes Bay Fishing Corporation management is meeting to discuss recent financial results and to plan for the future. John Singh, the sales manager, has been successful in convincing Keith to keep the boats close in price, basing his argument on the fact that the boats are the same size and about the same weight. In fact, he argues, each boat has the same seating capacity and is used for essentially the same purpose. Keith, however, is concerned. He has reviewed the financial results for the boating business and is confused by the results. Keith has noticed that while sales volume is increasing, profits are decreasing (as a percent of sales). Keith has consulted with his production manager, Jeff Knowles, who told him that he is doing his best to manage production costs but is challenged by the fact that the proportion of Trolling Deluxe boats manufactured and sold is growing at a far greater rate than the Fish Hauler.

Keith has asked his CFO, Janet Costa, for financial data regarding the sales and manufacturing activities for the past year. The following is what Janet provided.

Fish Hauler

Trolling Deluxe

Direct materials per unit

$6,150

$8,200

Direct labour hours per unit

44.5

58

Units sold

245

134

Stokes has been applying variable overhead on the basis of direct labour hours. For the past year, factory overhead was $640,000 and total direct labour hours for the year were18,600. The hourly rate for direct labour hours is $22. Also, sales and administrative expenses for the year totalled $984,000.

Keith has hired a financial consultant, Sue Wong, to analyze the activity of the past year, and to help management to understand the deteriorating profit results. Sue specializes in the application of activity-based costing (ABC) in small manufacturing businesses. The focus of her work was to determine key activities, cost drivers, and related costs in the business. Sue has found several overhead activities and related costs, and the associated cost drivers. She has also determined the amount of each activity consumed by the two products. This information is presented below.

Activities and Cost Drivers:

            Factory Overhead

Activity Centre

Cost Driver

Materials handling

Number of material movements

Engineering

Number of engineering hours

Equipment setup

Number of setups

Testing

Number of testing hours

Purchasing raw materials

Number of purchase orders

Activities and Cost Drivers:

            Factory Overhead

Activity Centre

Activity Cost

Activity Volume

Materials handling

$116,000

2,634 movements

Engineering

135,000

1,585 hours

Equipment setup

155,990

647 setups

Testing

84,500

750 testing hours

Purchasing raw materials

138,000

1,294 purchase orders

Financial data for the two products, based on ABC analysis:

Fish Hauler

Trolling Deluxe

Direct materials

$6,150

$8,200

Direct labour hours

44.5

58

Materials handling movements

2

16

Engineering hours

1

10

Number of setups

1

3

Testing hours

0.6

4.5

Purchase orders required

2

6

Units sold

245

134

Required:

  1. Calculate unit cost using the current process costing system. Calculate gross and net operating income generated for the company by the two products.
  2. Calculate activity rates, rounding to the nearest dollar.
  3. Calculate unit cost using activity-based costing, and recalculate gross and net operating income generated by the two products.
  4. Based on the results above, what advice would you give to Keith regarding his observation of increasing volume but decreasing profit?

Solutions

Expert Solution

1)Current process costing system: CALCULATIONS:
Fish Hauler Trolling Deluxe total
Revenues 2940000 1943000 245*12000 134*14500
Less: Expenses:
Dir mate. 1506750 1098800 6150*245 134*8200
Direct Lab. 239855 170984 245*44.5*22 134*58*22
Overhead 375140 267424 (640000*44.5/18600)*245 (640000*58/18600)*134
total 2121745 1537208
Gross Profit 818255 405792 1224048
Less:Selling and Admin exp's 984000
Net Operating Income 240048
2) Activity overhead rate under ABC :
Activity rate= Activity costs/Activity Volume Activity rate
Materials handling 116000/2634 44.03948367502 per movement
Engineering 135000/1585 85.17350157729 per hour
Equipment setup 155990/647 241.09737248841 per setup
Testing 84500/750 112.66666666667 per testing hour
Purchasing Raw materials 138000/1294 106.64605873261 per purchase order
3) Under ABC method the Gross Profit and operating profits:
Fish Hauler Trolling Deluxe total
Revenues 2940000 1943000 245*12000 134*14500
Less: Expenses:
Dir mate. 1506750 1098800 6150*245 134*8200
Direct Lab. 239855 170984 245*44.5*22 134*58*22
Overhead:
Materials handling 21579 94421 245*2*44.039483675019 134*16*44.039483675019
Engineering 20868 114132 245*1*85.1735015772871 134*10*85.1735015772871
Equipment setup 59069 96921 245*1*241.097372488408 134*3*241.097372488408
Testing 16562 67938 245*0.6*112.666666666667 134*4.5*112.666666666667
Purchasing Raw materials 52257 85743 245*2*106.646058732612 134*6*106.646058732612
total 1916939 1728940
Gross Profit 1023061 214060 1237121
Less:Selling and Admin exp's 984000
Net Operating Income 253121
We will advice Keith that it is not the volume of business which is bringing profits
down, but the incorrect method of allocating overhead.

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