Question

The Perkins Cove Yacht Company Case

The Perkins Cove Yacht Company Case Perkins Cove Yacht Company produces three models of yachts. All are 44 feet long. One is a standard Fiberglass model with nylon sails and a fixed keel made of lead and fiberglass named the Goose Rocks. It comes with a standard depth finder, compass and 20 horsepower diesel auxiliary motor. It sells for $120,000. The Kennebunkport model has upgrades with radar, GPS nautical charts, enhanced batteries, and Teflon coated carbon fiber sails. The engine produces 100 horsepower and can run a cabin heater. It can completely recharge the battery in less than an hour. The Kennebunkport sells for $200,000. The Ogunquit model is a custom-made with a deck made from teak and a cabin constructed from special woods. The sails are made from the traditional flax based canvass. The hull is from specially cut oak from local forests. It has the look of a vessel constructed in 1850 by a quality Maine shipyard with 2016 comforts and safety. The Ogunquit sells for $800,000. Workers who build the Ogunquit are specialty craftsmen. They earn twice the hourly rate of those working on the two standard models. Note: Labor rate is fully loaded for benefits. Most of Perkins Cove Yacht’s sales come from the Goose Rocks and the Kennebunkport, but sales of the Ogunquit model have been growing. Below is the company's sales, production, and cost information for last year:

Yacht	Goose Rocks	Kennebunkport	Ogunquit
Volume	50	100	20
Price	$120,000	$200,000	$800,000
Unit costs
Direct Materials	$30,000	$82,000	$250,000
Direct Labor	$36,000	$51,000	$440,000
Manufacturing Overhead*	$27,000	$27,000	$27,000
Total Unit Cost	$93,000	$160,000	$717,000
Unit Gross Profit	$27,000	$40,000	$83,000
Direct Labor hours	1,000	1000	4750
Rate per Hour	$36.00	$51.00	$92.63

Manufacturing overhead* is made up as follows:

Depreciation	$2,200,000
Maintenance	$700,000
Purchasing	$180,000
Inspection	$350,000
Indirect Materials	$290,000
Supervision	$800,000
Supplies	$70,000
Total Manufacturing Overhead Cost	$4,590,00

*these manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing.

The company allocates overhead costs using the traditional method. Its activity base is unit volume. The predetermined overhead rate, based on 170 total yachts, is $27,000 per yacht ($4,590,000 ÷ 170 yachts). Richard Perkins, president of Perkins Cove yacht, is concerned that the traditional cost-allocation system the company is using may not be generating accurate information and that the selling price of the custom Ogunquit may not be covering its true cost.

Questions:

A. The cost-allocation system Perkins Cove has been using allocates over 88% of overhead costs to the Goose Rocks and the Kennebunk because 88% of yachts produced were these two models. How much overhead was allocated, in total, to each of the three models last year? Discuss why this might not be an accurate way to assign overhead costs to products.

B. Perkins Cove’s production manager proposes allocating overhead by direct labor hours instead since the different models require different amounts of labor. How much overhead would be allocated to each yacht (per unit and in total) under this method? Show all supporting calculations.

C. How would the use of more than one cost pool improve Perkins Cove Yacht's cost allocation?

D. Perkins Cove Yacht's controller developed the following data for use in activity-based costing:

Manufacturing Overhead	Amount	Cost Driver	Goose Rocks	Kennebunkport	Ogunquit
Depreciation	$2,200,000	Square feet	20,000	30,000	30,000
Maintenance	$700,000	Direct labor hours	50,000	100,000	95,000
Purchasing	$180,000	# of purchase orders	1,500	1,500	6,000
Inspection	$350,000	# of Inspections	400	800	2,000
Indirect Materials	$290,000	Units Manufactured	50	100	20
Supervision	$800,000	# of Inspections	400	800	2,000
Supplies	$70,000	Units manufactured	50	100	20
Total	$4,590,000

Use activity-based costing to allocate the costs of overhead per unit and in total to each yacht. Show all supporting calculations. It is appropriate to use an excel document to do your computations in Excel.

E. Calculate the cost of one custom Ogunquit yacht using activity-based costing.

F. Why are the costs different between the traditional method and the activity-based method?

G. At the current selling price, is the company covering its true cost of production of the Ogunquit? Briefly discuss.

H. What should be the price that Perkins Cove Yacht Company charges for the Ogunquit? Assume that the Ogunquit should have the same profit margin as the Kennebunkport. Show all calculations.

I. What should Perkins Cove Yacht Co. do if the quantity of the Ogunquit yachts sold at the new price falls to 10 per year?

J. What should Perkins Cove Yacht Co. do about the situation if the price of the Ogunquit cannot exceed $800,000?

K. At a selling price of $800,000 each, what is the breakeven unit volume for the Ogunquit?

L. What are the lessons learned from this case?

Required Reading

* What is cost behavior: http://www.accountingcoach.com/blog/what-is-cost-behavior

*Activity Based Costing and Indirect Manufacturing Costs .

Capital budgeting:http://www.teachmefinance.com/capitalbudgeting.html

Answer 1

Part A) If we calculate the overhead distribution of last year as per the cost allocation method used by the company (i.e dividing total amount of overheads with number of units) then by multiplying per unit overhead cost of $27000 with volume expenses allocated comes out to be :

Product	Amount	% of Total Cost	Calculation
Goose Rocks	1350,000	29.41%	50 units x $27000 per unit
Kennebunkport	2700,000	58.83%	100 unita x $27000 per unit
Ogunquit	540,000	11.76%	20 units x $27000 per unit
Total	4590,000	100.00%

Calculate percentage of Sales contributed by each product

Product	Units	Sale price per unit	Sale Amount	% of Total sales
Goose Rocks	50	120,000	6,000,000	14.28%
Kennebunkport	100	200,000	20,000,000	47.62%
Ogunquit	20	800,000	16,000,000	38.10%
Total			42,000,000	100.00%

As we can see that Sale contributed by Goose Rocks is 14.28% of Total sales but Cost allocated to Goose Rocks is 29.41% of Total Overheads.

Hence it is not the best method to distribute the overheads among Products.

Part B) Allocation of overheads on the basis of Direct Labour Hours

Firstly we have to calculate total labour hours.

Product	Direct Labour Hours per unit	No. of units	Total Hours
Goose Rocks	1000	50	50,000
Kennebunkport	1000	100	100,000
Ogunquit	4750	20	95,000
Total	Total		245,000 Hrs

to calcute overhead rate per hour we will divide total overhead of $4590,000 with total direct labour hours i.e.245,000. Hence overhead rate will be 18.735 per labour hour. Overheads allocated to each product will be :

Product	Labour Hours in Total	Labour Hours per Unit	Overhead Rate	Amount allocated per unit (Col 3 x col 4)	Amount of overhead allocated (col 2 x col 4)
Goose Rocks	50,000	1000	18.735	18735	9,36,750
Kennebunkport	100,000	1000	18.735	18735	18,73,500
Ogunquit	95,000	4750	18.735	88991.25	17,79,825
	Total				4590075 or approx 4590000

Part C) Use of more than one cost pool can divide the individual expenses according to their utilisation by each product which will in return calculate the exact profit earned by selling each product. If we know exact cost of each product then it can further help us to focus on cost reduction strategies for each product and increasing the sale of product which provide maximum profit.

Part D) Allocation of overheads using Activity Based Costing Method :

Overhead	Cost Driver	Goose Rocks	Kennebunkport	Ogunquit	Total of Col 3,4,5	Overhead Amount	Overhead cost per unit of cost driver (col 7/ Col 6)
Depreciation	Square Feet	20000	30000	30000	80000	2200000	27.5
Maintenance	Direct Labour Hours	50000	100000	95000	245000	700000	2.85
Purchasing	# purchase of order	1500	1500	6000	9000	180000	20
Inspection	# of Inspection	400	800	2000	3200	350000	109.375
Indirect Materials	Units Manufactured	50	100	20	170	290000	1705.88
Supervision	# of Inspections	400	800	2000	3200	800000	250
Supplies	Units Manufactured	50	100	20	170	70000	411.76
			Total			4590000

Basis on the above calculation we will calculate overhead allocation per yacht.

Overhead	Rate per cost driver	Goose rocks cost driver	Amount Goose Rocks	Kennebunkport cost driver	Amount Kennebunkport	Ogunquit Cost driver	Amount Ogunquit
Depreciation	27.5	20000	550,000	30000	825000	30000	825000
Maintenance	2.85	50000	142500	100000	285000	95000	270750
Purchasing	20	1500	30000	1500	30000	6000	120000
Inspection	109.375	400	43750	800	87500	2000	218750
Indirect Material	1705.88	50	85294	100	170588	20	34117.6
Supervision	250	400	100000	800	200000	2000	500000
Supplies	411.76	50	20588	100	41176	20	8235.2
Total			972132		1639264		1976852.80

Grand Total of three Products will be $ 4588248.8 (972132 + 1639264 + 1976852.80) which is $1751.20 short than total expenses. This is due to rounding off of rates but we have to allocate this difference among products. Hence we will divide $1751.20 in ratio of total allocated ovrheads to each product (i.e.1751.2/4588248.8).answer will be multiplied by each overhead. Hence Final allocation will be

Product	Overhead total	Allocated Difference	Total Overhead allocated to product
Goose Rocks	972132	371	972503
Kennebunkport	1639264	626	1639890
Ogunquit	1976852.8	754.2	1977607
Total	4588248.8	1751.2	4590000

If we need to calculate for each unit of yacht we will divide cost allocated with volume of product. Hence overhead rate per yacht will be:

Goose Rocks - $19450.06

Kennebunkport - $16398.90

Ogunquit - $ 98880.35