Question

CarryAll Company produces briefcases from leather, fabric, and synthetic material in a single production department. The basic product is a standard briefcase that is made from leather, lined with fabric. CarryAll has a good reputation in the market because the standard briefcase is a high quality item and has been well-produced for many years. Last year, the company decided to expand its product line and produce specialty briefcases for special orders. These briefcases differ from the standard in that they vary in size, they contain both leather and synthetic materials, and they are imprinted with the buyer’s logo, whereas the standard briefcase is simply imprinted with the CarryAll name in small letters. The use of some synthetic materials in the briefcase was made to hold down the materials costs. To reduce the labor costs per unit, most of the cutting and stitching on the specialty briefcases is done by automated machines which are used to a much lesser degree in the production of the standard briefcases. Because of these changes in the design and production of the specialty briefcases, CarryAll believed that they would cost less to produce than the standard briefcases. However, because they are specialty items, they were priced slightly higher—standards are priced at $30, specialty briefcases at $32. After reviewing last month’s results of operations, CarryAll’s President became concerned about the profitability of the two product lines because the standard briefcase showed a loss while the specialty briefcase showed a greater profit margin than expected. The President is wondering whether the company should drop the standard briefcase and focus entirely on specialty items. The cost data for last month’s operations as reported to the President are as follows:

Standard                                                               Specialty

Units Produced:                                                                                  10,000                                                    2,500

                Direct Materials:

                Leather                                  1.0 sq. yd.                                              $15.00       0.5 sq. yd.                         $ 7.50

                Fabric                                     1.0 sq. yd.                                                   5.00       1.0 sq. yd.                               5.00

                Synthetic                                                                                                 ____                                                        5.00

                Total Materials:                                                                                   $20.00                                                 $17.50

                Direct Labor:                        0.5 hr @ $12.00                                         6.00       0.25 hr. @ $12.00                 3.00

                Factory Overhead:              0.5 hr. @ $ 8.98                                         4.49      0.25 hr. @ $ 8.98                  2.24

                Cost per Unit                                                                                        $30.49                                                 $22.74

Factory overhead is applied on the basis of direct-labor hours. The rate of $8.98 per direct-labor hour was calculated by dividing the total overhead $50,500 for the month by the direct-labor hours of 5,625. As shown above, the cost of a standard briefcase is $0.49 higher than its $30 sales price whereas the specialty briefcase has a cost of only $22.74 for a gross profit per unit of $9.26. The problem with these costs is that they do not accurately reflect the activities involved in manufacturing each product. Determining the costs using ABC should provide better product costing data to help gauge the actual profitability of each product line.

Analyzing the Factory Overhead Costs The factory overhead costs must be analyzed to determine the activities causing the costs. Assume that the following costs and cost drivers have been identified.

Purchasing Department cost is $6,000. The major activity driving the purchasing department costs is the number of purchase orders processed. During the month, purchasing prepared the following number of purchase orders: For leather 20 For fabric 30 For synthetic material 50

Receiving and Inspecting Materials cost is $7,500. Receiving and inspecting costs are driven by the number of deliveries. During the month, the following number of deliveries were made: Leather 30 Fabric 40 Synthetic material 80

Setting Production Line cost is $10,000. Set-up activities involve changing the machines to produce the different types of briefcases. A set-up for production of the standard briefcases requires one hour while set-up for the specialty briefcases requires two hours. Standard briefcases are produced in batches of 200; specialty briefcases are produced in batches of 25. During last month, there were 50 set-ups for the standard items and 100 set-ups for the specialty items.

Inspecting Finished Goods cost is $8,000. All briefcases are inspected to ensure that quality standards are met. However, the final inspection of standard briefcases takes very little time because the employees identify and correct quality problems as they do the hand-cutting and stitching. A survey of the personnel responsible for inspecting the final products showed that they spent 150 hours on the standard briefcase and 250 hours on the specialty ones during the month.

Equipment Related costs are $6,000. Equipment related costs include repairs, depreciation and utilities. Management has determined that a logical basis for assigning these costs to products is machine hours. A standard briefcase requires ½ hour of machine time, and a specialty briefcase requires 2 hours. Thus, during the last month, 5,000 hours of machine time relate to the standard line and 5,000 hours relate to the specialty line. Plant Related costs are $13,000. Plant related costs include property taxes, insurance, administration and others. These costs are to be assigned to products using machine hours.

Required: a. Using activity-based costing concepts, what overhead costs are assigned to the two products?

b. What is the unit cost of the two products using activity-based costing concepts?

c. Reevaluate the President’s concern about the profitability of the two

Answer 1