Question:
“A dollar of gross margin per briefcase? That’s ridiculous!†roared Art Dejans, president of CarryAll, Inc. “Why do we go on producing those standard briefcases when we’re able to make over $15 per unit on our specialty items? Maybe it’s time to get out of the standard line and focus the whole plant on specialty work.â€
Mr. Dejans was referring to a summary of unit costs and revenues that he had just received from the company’s Accounting Department:
CarryAll produces briefcases from leather, fabric, and synthetic materials in a single plant. The basic product is a standard briefcase that is made from leather lined with fabric. The standard briefcase is a high quality item and has sold well 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 the finest leather and synthetic materials, and they are imprinted with the buyer’s name. To reduce labor costs on the specialty briefcases, automated machines do most of the cutting and stitching. These machines are used to a much lesser degree in the production of standard briefcases.
“I agree that the specialty business is looking better and better,†replied Sally Henrie, the company’s marketing manager. “And there seems to be plenty of specialty work out there, particularly because the competition hasn’t been able to touch our price. Did you know that Armor Company, our biggest competitor, charges over $50 a unit for its specialty items? Now that’s what I call gouging the customer!â€
A breakdown of the manufacturing cost for each of CarryAll’s product lines is given below:
Manufacturing overhead is applied to products on the basis of direct labor-hours. The rate of $18 per direct labor-hour is determined by dividing the total manufacturing overhead cost for a month by the direct labor-hours:
Predetermined overhead rate = Manufacturing overhead / Direct labor-hours
= $101,250 / 5,625 DLHs = $18 per DLH
The following additional information is available about the company and its products:
a. Standard briefcases are produced in batches of 200 units, and specialty briefcases are produced in batches of 25 units. Thus, the company does 50 setups for the standard items each month and 100 setups for the specialty items. A setup for the standard items requires one hour, whereas a setup for the specialty items requires two hours.
b. All briefcases are inspected to ensure that quality standards are met. A total of 300 hours of inspection time is spent on the standard briefcases and 500 hours of inspection time is spent on the specialty briefcases each month.
c. A standard briefcase requires 0.5 hours of machine time, and a specialty briefcase requires 2 hours of machine time.
d. The company is considering the use of activity-based costing as an alternative to its traditional costing system for computing unit product costs. Since these unit product costs will be used for external financial reporting, all manufacturing overhead costs are to be allocated to products and nonmanufacturing costs are to be excluded from product costs. The activity-based costing system has already been designed and costs allocated to the activity cost pools. The activity cost pools and activity measures are detailed below:
Required:
1. Using activity-based costing, determine the amount of manufacturing overhead cost that would be applied to each standard briefcase and each specialty briefcase.
2. Using the data computed in part (1) above and other data from the case as needed, determine the unit product cost of each product line from the perspective of the activity-based costing system.
3. Within the limitations of the data that have been provided, evaluate the president’s concern about the profitability of the two product lines. Would you recommend that the company shift its resources entirely to production of specialty briefcases? Explain.
4. Sally Henrie stated that “the competition hasn’t been able to touch our price†on specialty business. Why do you suppose the competition hasn’t been able to touch CarryAll’s price?
Transcribed Image Text:
Standard Specialty Briefcases Briefcases Selling price per unit Unit product cost. $36 $40 35 25 Gross margin per unit.. $ 1 $15 Specialty Briefcases Standard Briefcases Units produced each month.. 10,000 2,500 Direct materials: Leather. $15.00 $ 7.50 Fabric. 5.00 5.00 Synthetic. 5.00 Total direct materials 20.00 17.50 Direct labor (0.5 DLH and 0.25 DLH @ $12 per DLH) . Manufacturing overhead (0.5 DLH and 0.25 DLH @ $18 per DLH).. 6.00 3.00 9.00 4.50 Total cost per unit. $35.00 $25.00 Estimated Activity Cost Pool Activity Measure Overhead Cost $ 12,000 Purchasing. Material handling Production orders and setup Inspection Frame assembly. Number of orders Number of receipts Setup hours Inspection-hours Assembly-hours Machine-hours 15,000 20,250 16,000 8,000 Machine related. 30,000 $101,250 Expected Activity Standard Specialty Briefcase Activity Measure Briefcase Total Number of orders: Leather.. 34 6 40 Fabric. Synthetic material Number of receipts: 48 12 60 100 100 Leather.. 52 60 Fabric.. Synthetic material Setup hours. Inspection-hours. Assembly-hours. 64 16 80 160 160 ? ? ? ? ? ? 800 800 1,600 Machine-hours.. ? ? ?
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