Question

Beztec Limited produces two models of Printers: the Lexon, which Beztec has produced since 2014 and sells for $990; and the Protox, a newer model introduced in 2016 that sells for $1254. Based on the following income statement for the year ended 31 December 2017, senior management at Beztec have decided to concentrate marketing resources on the Protox model and to begin to phase out the Lexon model because the Protox generates a much bigger operating profit per unit.

Beztec Limited Income statement for the financial year ended 31December 2017
	Lexon	Protox	Total
Revenues	$23 760 000	$7524 000	$31 284 000
Cost of goods sold	15 048 000	5 266 800	20 314 800
Gross margin	8 712 000	2 257 200	10 969 200
Selling and administrative expense	6 996 000	1 613 700	8 609 700
Operating income	$1 716 000	$643 500	$2 359 500
Units produced and sold	24 000	6 000
Operating income per unit sold	$71.50	$107.25

Details for cost of goods sold for Lexon and Protox are:

	Lexon		Protox
Costs	Total	Per unit	Total	Per unit
Direct materials	$5 491200	$228.80	$3 854 400	$642.40
Direct production laboura	475 200	19.80	277 200	46.20
Machineb	3 801 600	158.40	475 200	79.20
Total direct	$9 768 000	$407.00	$4 606 800	$767.80
Production overheadc	$5 280 000	$220.00	$660 000	$110.00
Total cost of goods sold	$15 048 000	$627.00	$5 266 800	$877.80

^a Lexon requires 1.5 hours per unit and Protox requires 3.5 hours per unit. The direct production labour rate is $13.20 per hour.

^bMachine costs include lease costs of the machine, repairs and maintenance. Lexon requires 8 machine-hours per unit and Protox requires 4 machine-hours per unit. The machine-hour rate is $19.80 per hour.

^c Production overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.

Beztec’s management accountant, Sue Smith, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s production overhead costs for the year ended 31December 2017.

		Activity-cost-driver quantities
Activity-cost driver (driver quantity)	Total activity costs	Lexon	Protox	Total
Soldering (number of solder points)	$1 165725	1 333 125	433 125	1 766 250
Shipments (number of shipments)	1 064 250	18 225	4 275	22 500
Quality control (number of inspections)	1 534 500	63 225	23 963	87 188
Purchase orders (number of orders)	1 176 120	90 113	123 727	213 840
Machine power (machine-hours)	71 280	198 000	18 000	216 000
Machine set-ups (number of set-ups)	928 125	18 000	15 750	33 750
Total production overhead	$5 9400 000

After completing her analysis, Smith shows the results to Steven Kay, the CEO of Beztec. Kay does not like what he sees. ‘If you show headquarters this analysis, they are going to ask us to phase out the Protox line, which we have just introduced. This whole costing stuff has been a major problem for us. First, Lexon was not profitable and now Protox.

      ‘Looking at the ABC analysis, I see problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. We can’t afford to phase out either product, please alter the costs produced by the ABC system.’

Smith knows that her numbers are fairly accurate. As a quick check, she calculates the profitability of Lexon and Protox using more and different activity drivers. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is confident that headquarters, knowing that Protox was introduced only recently, will not phase out Protox. She is also aware that a sizeable portion of Kay’s bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Kay to do something. She asks for your advice.

Requirements:

a) Calculate the cost driver rates for the various activities identified in the activity-based costing (ABC) system.

b) Calculate the cost of each model under activity based costing.

Answer 1

Calculation of activity rates
Activity-cost driver (driver quantity)	Total activity costs	Total	Activity rates
Soldering (number of solder points)	1165725	1766250	0.66
Shipments (number of shipments)	1064250	22500	47.3
Quality control (number of inspections)	1534500	87188	17.60
Purchase orders (number of orders)	1176120	213840	5.5
Machine power (machine-hours)	71280	216000	0.33
Machine set-ups (number of set-ups)	928125	33750	27.5
	5940000
Calculation of cost of each model
	Lexon		Protox
Costs	Total	Per unit	Total	Per unit
Direct materials	5491200	$228.80	3854400	$642.40
Direct production laboura	475200	19.8	277200	46.2
Machineb	3801600	158.4	475200	79.2
Total direct	976800	$407.00	4606800	$767.80
Production overheadc
Soldering (number of solder points)	879863	37	285863	47.64
Shipments (number of shipments)	862043	36	202208	33.70
Quality control (number of inspections)	1112754	46	421746	70.29
Purchase orders (number of orders)	495622	21	680499	113.42
Machine power (machine-hours)	65340	3	5940	0.99
Machine set-ups (number of set-ups)	495000	21	433125	72.19
Total overhead	3910620	163	2029380	338.23
Cost of each model	4887420	204	6636180	1106.03