Question

FINANCIAL INFORMATION

CMI budgeted direct labor costs for 2010 at $60,000,000. Based on expected sales, the company estimated that raw material purchased and used would be $300,000,000. Manufacturing overhead was budgeted at $196,000,000. It is currently allocated to production on the basis of machine hours (MH). As mentioned above, computers are priced at full production cost plus a mark-up of 50%.

EXHIBIT 1 shows the expected direct manufacturing costs for two of the company’s computers. The Cortland 1000 is a very popular computer with a large production and sales volume. By contrast, the Cortland 2000, described above, is a state-of-the-art scientific computer with several special features. In particular, the Cortland 2000

Uses a new processing chip imported from Sweden.

Has special patented random access memory (RAM) that gives it extremely high input/output speed.

Is manufactured in very small batches to assure uniform quality from one computer to the next, to satisfy the users of the machines who have very high expectations for the performance of the machines they purchase.

Mr. Works’ concerns arose when Ms. Nomer told him that she thought the company’s traditional overhead allocation system was providing misleading cost information about the different types of products. She developed an analysis of the 2010 manufacturing overhead costs, shown in EXHIBIT 2. She classified the overhead costs described above into activities. She also gathered data, shown in EXHIBIT 3, for the 2010 production of the Cortland 1000 and the Cortland 2000. Mr. Works commented on the data:

I don’t know quite what to make of all this. Clearly I need some further explanation and analysis. I guess what I really need is some sense of what is the true manufacturing cost of each computer. I thought I knew that, but I didn’t really. Even though we cannot at this point change prices for 2010, we at least need to know if we’re covering full production cost on the Cortland 2000 and have something left to contribute to the company’s selling, general and administrative expenses. I thought this was so, but now … well, I’m not so sure. We’d better figure this out before we begin our budget cycle for 2011. Maybe I need to go back to school!

EXHIBIT 1

Direct Manufacturing Costs for ONE Computer

	Cortland 1000	Cortland 2000
Direct Material	$1,000	$2,500
Direct Labor	$200	$400

EXHIBIT 2

Analysis of 2010 Budgeted Manufacturing Overhead Costs

Activity	Cost driver	Budgeted activity (for entire company)	Budgeted cost
Receive/handle raw material	Orders received	200 orders	$90,000,000
Adjust/set up machines	Number of setups	2,000 setups	$12,000,000
Inspect, pack, ship computers	Batches	500 batches	$60,000,000
Inspect raw materials	Inspection hours	200,000 insp. hr.	$10,000,000
Solder parts	Soldering hours	200,000 sdr. hr.	$12,000,000
Assemble computers	Assembly hours	100,000 assm. hr.	$12,000,000
Total overhead			$196,000,000

EXHIBIT 3

Production Data for Cortland 1000 and Cortland 2,000 Computers

Item	Measure	Cortland 1000	Cortland 2000
Budgeted production	Number of computers	20,000	5,000
Received order size*	Size of order	10,000	500
Batch size	Number of computers	5,000	100
Machine setups	Number of s/u per batch	5	6
Inspecting time (Raw mat.)	Hours / computer	1	2
Soldering time	Hours / computer	3	1
Assembly time	Hours / computer	1	1

* “Received order size” is the number of computers one order of raw materials will build. Thus, for example, (see above) the company receives 2 orders of raw materials for the Cortland 1,000. Calculation: 20,000 computers per year, divided by 10,000 computers each order will build = 2 orders per year.

REQUIRED:

Calculate the predetermined overhead rate the company is currently using. (Where should you look for the machine hours?)

Using the information from the exhibits and Q1, calculate the manufacturing cost of ONE Cortland 1000 and ONE Cortland 2000.

Calculate the selling price, under the current system, of ONE Cortland 1000 and ONE Cortland 2000.

Next, you are going to begin to analyze the ABC system. In order to do this, however, your study of Exhibits 2 and 3 should have told you that you are going to have to convert the information the company currently measures into the information you need for the ABC analysis. First, how many raw material orders did the company receive for each model?

How many batches of each model did the company pack and ship?

How many machine setups does Cortland do for each model?

Calculate a rate for each activity in Exhibit 2.

Use the rates calculated in Q7 to apply overhead to each product line: Cortland 1000 and 2000.

Calculate the overhead per computer for a Cortland 1000 and a Cortland 2000.

Calculate the manufacturing cost of ONE Cortland 1000 and ONE Cortland 2000 using ABC overhead allocation.

Show how the company would determine a selling price for each model under the ABC system.

Should Mr. Works adopt an ABC system for internal analysis? Your answer should address the question very specifically to this case – no generalities about ABC from the book. It should contain two points in favor of ABC, and two drawbacks that he should be aware of.

Mr. Works is also concerned about future product development. They have several new models under development at this time. If an ABC system is used, list two characteristics of a new model that will make it more costly to manufacture.

Don’t try to begin answering questions until you have studied the case information carefully. Careless reading will result in errors!

BACKGROUND

CMI manufactures several different models of computers, distributed to retail outlets throughout the 50 states. The company is proud of the user-friendly computers it produces, in particular their graphics capability. CMI claims the superb graphics are what distinguish its products from competitors.

CMI purchases raw materials in components and subassemblies made to its specifications from a very small group of highly reliable suppliers. It uses a single facility to house both manufacturing facility and administrative and sales offices.   The factory workers operate three kinds of machines. Inspecting machines check the raw materials and test components and subassemblies to assure they are working to specifications. Soldering machines solder various components as necessary. Finally assembly machines put all the components and subassemblies together into finished computers. The processes can vary by computer model.

Depreciation, maintenance and repairs on the three types of machines account for about 40% of CMI’s overhead cost. The remainder of the overhead is made up of labor involved in receiving and handling the raw materials, adjusting and setting up machines for each new batch of computers, and inspecting and packing finished computers for shipping. Additional costs include insurance and depreciation on handling equipment, supplies, and utilities. The actual manufacturing effort (soldering, inspecting and assembly) is primarily automated, so CMI uses very little direct labor. The company also operates on a lean production model, so almost no inventories exist at the end of any period.

Most of the computers are sold in large orders to national electronic chains. However, the Cortland 2000 is not such a machine. It represents a recent effort by CMI to enter the scientific computing market. The quantity manufactured and sold of this machine is expected to be much lower than other models even when it gains its hoped-for market share. Fewer customers exist for this more sophisticated, powerful, high-priced machine. Nonetheless, Mr. Works has believed from the conception of this product that, when all manufacturing costs were considered, the Cortland 2000 would contribute a reasonable amount to CMI’s selling and administrative costs and profit. The name recognition it brought in its elite community should enhance sales of the more generally used computers.

Answer 1

1.	Calculate the predetermined overhead rate the company is currently using.
	Estimated Overhead	196000000
	Machine Hours	500000
	200000+200000+100000
	Predetermined Overhead Rate	196000000/500000
	(Estimated OVH/Machine Hours)	392
2.	calculate the manufacturing cost of ONE Cortland 1000 and ONE Cortland 2000.
		Cortland 1000	Cortland 2000
	Direct Material	1000	2500
	Direct Labor	200	400
	Fixed Overhead
	(392*5 Hour)	1960
	(392*4 Hour)		1568
	Total Manufacturing Cost	3160	4468
3.	Calculate the selling price,
	Total Manufacturing Cost	3160	4468
	Mark Up 50%	1580	2234
	Selling Price	4740	6702
4.	how many raw material orders did the company receive for each model?
	Item	Measure	Cortland 1000	Cortland 2000
A	Budgeted production	Number of computers	20000	5000
B	Received order size*	Size of order	10000	500
A/B	No of R/M order		2	10
5.	How many batches of each model did the company pack and ship?
	Item	Measure	Cortland 1000	Cortland 2000
A	Budgeted production	Number of computers	20000	5000
B	Batch size	Number of computers	5000	100
	No of Batches A/B		4	50
6.	How many machine setups does Cortland do for each model?
	Item	Measure	Cortland 1000	Cortland 2000
A	Machine setups	Number of s/u per batch	5	6
B	No of Batches A/B		4	50
A*B	Machine Setups		20	300
7.	Calculate a rate for each activity in Exhibit 2.
			A	B	A/B
	Activity	Cost driver	Budgeted activity (for entire company)	Budgeted cost	Rate
	Receive/handle raw material	Orders received	200 orders	$90,000,000	450000	per order
	Adjust/set up machines	Number of setups	2,000 setups	$12,000,000	6000	per setup
	Inspect, pack, ship computers	Batches	500 batches	$60,000,000	120000	per batch
	Inspect raw materials	Inspection hours	200,000 insp. hr.	$10,000,000	50	per ins hr
	Solder parts	Soldering hours	200,000 sdr. hr.	$12,000,000	60	per sdr hr
	Assemble computers	Assembly hours	100,000 assm. hr.	$12,000,000	120	per assm hr
	Total overhead			$196,000,000