Question

Liz Ortega builds custom cabinets. The process usually begins with a preliminary visit to a potential customer location to take measurements and prepare a bid. Measurements and bidding are done by a salesperson. Many times, this preliminary visit does not result in an order. Once an order is received, there are a number of order-specific "shop setup" processes (calibrating saws, lathes, sanders, etc.). The "shop setup" process is the same no matter how many individual cabinets are produced for each order (i.e., some orders are for just a few cabinets, and some orders are for hundreds of identical units). Setup is followed by production, and the amount of time and labor is heavily correlated to the number of units produced in the order. The final step is delivery to the job site, and the cost for this activity is mostly a function of distance from shop to job site.
Liz has been applying factory overhead based on direct labor hours, and realizes that this costing model is sometimes ineffective in producing competitive and/or profitable bids. She has read about "activity-based costing" and is interested in perfecting her bidding process based upon ABC methodology.
Ortega's total cost for a recent period are as follows:
	Direct material		$    300,000
	Direct labor		200,000
	Indirect material		40,000
	Indirect labor		60,000
	Shop depreciation		150,000
	Shop maintenance		25,000
	Other shop costs		35,000
	Administrative salaries		90,000
	Sales salaries		55,000
	Transportation		20,000
Liz has examined her business and concluded that she has four basic activities: bidding, machine set up, production, and delivery. During the period for which the above costs were incurred, 75 jobs were bid, resulting in 25 orders. The ratio of bids to orders was about normal. Each order required a separate shop setup. There were 2,000 cabinets produced. Delivery distance for the orders totaled 4,000 miles. Ortega conducted a study to determine the portion of each cost category that is attributable to the four activities. The results of this study are summarized in the following table.
		Bidding	Set Up	Production	Delivery	Unallocated
	Indirect material	5%	15%	75%	5%	0%
	Indirect labor	10%	20%	50%	20%	0%
	Shop depreciation	0%	15%	80%	5%	0%
	Shop maintenance	0%	40%	55%	5%	0%
	Other shop costs	0%	60%	40%	0%	0%
	Administrative salaries	20%	0%	25%	10%	45%
	Sales salaries	95%	5%	0%	0%	0%
	Transportation	30%	0%	0%	60%	10%
(a)	Determine the total cost of each activity, and calculate a cost per unit of measure.
(b)	Ortega's salesperson has been asked to bid on an order involving 50 cabinet units. Delivery requires 60 miles of driving. If the goal is to price orders at 200% of the activity-based cost (including direct material and direct labor, but excluding unallocated costs), what price should be quoted?

Answer 1

a.

	Total Cost	Bidding	Setup	Production	Delivery	Unallocated
Indirect Material	40000	2000	6000	30000	2000
%		5%	15%	75%	5%
Indirect Labor	60000	6000	12000	30000	12000
		10%	20%	50%	20%
Shop Depreciation	150000	0	22500	120000	7500
		0%	15%	80%	5%
Shop Maintenance	25000	0	10000	13750	1250
		0%	40%	55%	5%
Other shop costs	35000	0	21000	14000	0
		0%	60%	40%	0%
Administrative salaries	90000	18000	0	22500	9000	40500
		20%	0%	25%	10%	45%
Sales Salaries	55000	52250	2750	0	0
		95%	5%	0%	0%
Transoprtation	20000	6000	0	0	12000	2000
		30%	0%	0%	60%	10%
Total Costs	475000	84250	74250	230250	43750	42500
Units of measure		75	25	2000	4000
		Bids	Orders	cabinets	miles
Cost perunit of measure		1123	2970	115	11

b. Price to be quoted : $69,000

Working:

Bid to be submitted
	Units	Rate	Value
Direct material	50	150	7500
Direct labor	50	100	5000
Indirect costs:
Bidding	1	1123	1123
Setup	1	2970	2970
Production	50	115	5750
Delivery	60	11	660
Total cost			23003
Markup   -- 200%			46006
Bid Price			69009