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Question: CableTech Bell Corporation (CTB) operates in the

CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
Expected activity demands:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division:
CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March’s performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March’s dismal performance was also typical for what has been happening this year and is expected to continue— unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB’s Phone Division had sales totaling $1,170,000 for March. Based on March’s results, Bryce decided to meet with three of the Phone Division’s managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: “March’s profit performance is down once again, and I think we need to see if we can identify the problem and correct it—before it’s too late. Kim, what’s your assessment of the situation?” Kim: “Foreign competition is eating us alive—selling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I’d like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it.” Larry: “They’re right. If we could lower our prices by 10 to 15 percent, I think that we’d regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I’d like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would be more satisfied with our products, and I bet that we would not only regain our market share but increase it.” Jacob: “Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.” Larry: “This sounds promising—especially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest difference—and if we knew they were over-costed, then we could offer immediate price reductions.” Bryce: “Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?” Jacob: “I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We trace—or attempt to trace—overhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don’t have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information—information that will allow us to assign costs more accurately.” Bryce: “This may be something we should explore. Jacob, what do you suggest?” Jacob: “If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit-drivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.” Bryce: “What do you think, Kim? It’s your division.” Kim: “What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I’ll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?” Jacob: “I have already been gathering data. I could probably have a report within two weeks.” MEMO: TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn’t explain a lot of the variation. I then searched for other drivers—particularly non unit drivers—that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn’t provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be over costing our high-volume products. Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties. In addition to the pilot study for one plant, I also collected information about these three activities for the division. For the inspection activity, we have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers a practical inspection capacity of 2,000 hours per year. However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacing some faulty components and the associated direct labor. The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential savings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant’s two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled “other manufacturing activities.” From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Expected activity demands: Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).
b. Allocation relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. c. Direct tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. d. Driver tracing relies on: a. exclusive physically observable causal relationships to assign costs. b. causal factors to assign costs. c. assumed linkages or convenience to assign costs. d. none of the above. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? Explain and discuss other differences between functional- and activity-based costing. 2. Prepare income statements for the Cable Service Division and for the Phone Division for March. For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Discuss the differences between the products of the two divisions. 3. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? b. Why is he attempting to measure it? c. How is it currently being measured, and how will the measurement approach change? d. Where did Jacob get the data needed to carry out the proposed analyses? e. Which analytic methods did Jacob use or propose to be used? f. When will the analysis be completed and ready for decision making? g. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the following: a. Direct labor cost formula: Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places) b. Formula for material handling cost (based on number of moves): Intercept (rounded to nearest dollar) Slope (Coefficient 1, rounded to the nearest cent) R Square (rounded to two decimal places c. The intercept can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. d. Coefficient 1 can be interpreted as: a. fixed cost. b. variable cost per unit. c. total cost. d. mixed cost. e. Comment on Jacob’s observations concerning the outcomes. 5. Answer the following: a. Inspection is a (select: variable, fixed, mixed, step-fixed) cost, with each (select: unit, step) being defined by ____?______ inspection hours per year. Each (select: unit, step) costs $____?_____. Current activity capacity for inspection is _____?______ hours. Current demand for the inspection activity is ____?_____ hours. b. Rework is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. c. Warranty is a: a. variable cost. b. fixed cost. c. mixed cost. d. step-fixed cost. d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by 50 percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March’s pre-tax operating income produced by the savings. 6. Using the data generated by Jacob’s pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products (round overhead rate to two decimal places). b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently (select: understated, overstated) by $____. d. If the unit product cost of the Regular model is (select: understated, overstated), then the selling price could be (select: increased, decreased), making the company (select: more, less) competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour. Calculate the unit cost for each model using duration-based costing. How do unit costs compare to the ABC costs? Which approach would you recommend to Kim? 8. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s).

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> Rosita thinks that it may be time to refuse to accept checks and to start accepting credit cards. She is negotiating with VISA/MasterCard and American Express, and she would start the new policy on April 1. Rosita estimates that with the drop in sales fr

> Rosita Flores owns Rosita’s Mexican Restaurant in Tempe, Arizona. Rosita’s is an affordable restaurant near campus and several hotels. Rosita accepts cash and checks. Checks are deposited immediately. The bank charges $0.50 per check; the amount per chec

> Gunnison Company had the following equivalent units schedule and cost information for its Sewing Department for the month of December: Required: 1. Calculate the unit cost for December, using the FIFO method. 2. Calculate the cost of goods transferred ou

> Tiger Drug Store carries a variety of health and beauty aids, including 500-count bottles of vitamins. The sales budget for vitamins for the first six months of the year is presented below. The owner of Tiger Drug believes that ending inventories should

> Video-Forward, Inc., designs and manufactures wearable video cameras. Models A-1, A-2, and A-3 are lightweight video cameras that can be used on arms and headbands. Models A-4 and A-5 have larger memory, better resolution, and more Wi-Fi-related features

> Macchu Company produces stuffed toy animals; one of these is “Andie the Llama.” Each Andie takes 0.30 yard of fabric and eight ounces of polyfiberfill. Fabric costs $3.50 per yard and polyfiberfill is $0.05 per ounce.

2.99

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