“A dollar of gross margin per briefcase? That’s ridiculous!” roared Janet Dejans
ID: 2716954 • Letter: #
Question
“A dollar of gross margin per briefcase? That’s ridiculous!” roared Janet Dejans, president of Cases Inc. “Why do we go on producing those standard briefcases when we’re able to make over $15 per unit on our specialty items? Maybe it’s time to get out of the standard line and focus the whole plant on specialty work.”
Dejans is referring to a summary of average unit costs and revenues that she had just received from the company’s accounting department:
Standard Briefcases
Specialty Briefcases
Selling Price per unit
$36.00
$50.00
Unit product cost
35.00
32.50
Gross margin per unit
1.00
17.50
Cases Inc. produces briefcases from leather, fabric, and synthetic materials in a single plant. The basic product is a standard briefcase made from leather lined with fabric. The standard briefcase is a high-quality item and has sold well for many years.
Last year, the company decided to expand its product line and produce specialty briefcases for special orders. These briefcases differ from the standard in that they vary in size, contain the finest synthetic materials, and have the buyer’s name embossed on them. To reduce labour costs on the specialty briefcases, most of the cutting and stitching is done by automated machines. These machines are used to a much lesser degree in the production of standard briefcases.
“I agree that the specialty business is looking better and better,” replied Sally Henrie, the company’s marketing manager. “And there seems to be plenty of specialty work out there, particularly since the competition hasn’t been able to touch our price. Did you know that Armour Company, our biggest competitor, charges over $65 a unit for its specialty items? Now that’s what I call gouging the customer!”
A breakdown of the manufacturing cost for each of Cases Inc’s product lines follows:
Standard Briefcases
Specialty Briefcases
Units produced each month
9,000
2,250
Direct Materials:
Leather………………..
1.0 m2
$15.00
0.5 m2
$7.50
Fabric…………………
1.0m2
5.00
1.0 m2
5.00
Synthetic………………
-----------
5.00
Total Materials……..
20.00
17.50
Direct Labour
0.5 h @ $12.00
6.00
6.00
Manufacturing Overhead
0.5 h @ $18.00
9.00
9.00
Unit Product Cost….
$35.00
$32.50
Manuafacturing overhead is applied to products on the basis of direct labour-hours. The rate of $18 per direct labour-hour is determined by dividing the total manufacturing overhead cost for a month by the direct labour-hours:
Manufacturing overhead cost, $101,250 = $18 per DLH
Direct Labour Hours, 5,625
The following additional information is available about the company and its products.
a.Standard briefcases are produced in batches of 200 units, and specialty briefcases are produced in batches of 25 units. Thus, the company does 45 setups for the standard items each month and 90 setups for the specialty items. A setup for the standard items requires 1 hour, whereas a setup for the specialty items requires 2 hours.
b.All briefcases are inspected to ensure that quality standards are met. A total of 300 hours of inspection time is spent on the standard briefcases and 500 hours of inspection time is spent on the specialty briefcases each month.
c.A standard briefcases requires 0.5 hours of machine time, and a specialty briefcase requires 2 hours of machine time.
d.The company is considering using ABC as an alternative to its traditional costing system for computing unit product costs. Since these unit product costs will be used for external financial reporting, all manufacturing overhead costs are to be allocated to products, and nonmanufacturing costs are to be excluded from product costs. The ABC system has already been designed and costs allocated to the activity cost pools. The activity cost pools and activity measures follow:
Activity Cost Pool
Activity Measure
Estimated Overhead Cost
Purchasing
Number of orders
$12,750
Materials Handling
Number of receipts
$15,000
Production orders and setup
Set-up Hours
$22,500
Inspection
Inspection Hours
$16,000
Frame Assembly
Assembly Hours
$8,000
Machine related
Machine Hours
$27,000
$101,250
_________________Expected Activity_______________
Activity Measure
Standard Briefcase
Specialty Briefcase
Total
Number of Orders
Leather….
24
46
70
Fabric…..
51
79
130
Synthetic Material
____
100
100
Number of Receipts
Leather….
46
14
60
Fabric…..
70
10
80
Synthetic Material
-----
160
160
Setup Hours
?
?
?
Inspection Hours
?
?
?
Assembly Hours
800
800
1,600
Machine Hours
?
?
?
Required:
1.Using ABC, determine the amount of manufacturing overhead cost that would be applied to each standard briefcase and each specialty briefcase.
2.Using the data computed in part (1) and other data from the case as needed, determine the unit product cost of each product line from the perspective of the ABC system.
3.Within the limitations of the data that have been provided, evaluate the president’s concern about the profitability of the two product lines. Would you recommend that the company shift its resources entirely to the production of specialty briefcases? EXPLAIN.
4.Henrie stated that the “competition hasn’t been able to touch our price” on specialty business. What do you think is the reason?
Standard Briefcases
Specialty Briefcases
Selling Price per unit
$36.00
$50.00
Unit product cost
35.00
32.50
Gross margin per unit
1.00
17.50
Explanation / Answer
Answer (1) Activity cost pool Standard Speciality Total Purchasing Amount * No of orders/total orders 3188 9563 12750 Materials Handling Amount * No of receipts / total receipts 5800 9200 15000 Production Orders and set up Amount * Hours of setup / total setup 4500 18000 22500 Inspection Amount * Inspected hours / total hours 6000 10000 16000 Frame Assembly Amount * Assembly hours / total hours 4000 4000 8000 Machine Related Amount * Machine Hours / Total hours 13500 13500 27000 Total Overheads 36988 64263 101250 Answer (2) Calculation of Unit Product cost Standard Speciality Units Produced each month 9000 2250 Direct Materials Leather Per Unit cost 15.00 7.50 Fabric Per Unit cost 5.00 5.00 Synthetic Per Unit cost 5.00 Total material cost 20.00 17.50 Direct Labour 0.5 hours at $12 6.00 6.00 Overheads Purchasing Amount / No of units produced 0.35 4.25 Materials Handling Amount / No of units produced 0.64 4.09 Production Orders and setup Amount / No of units produced 0.50 8.00 Inspection Amount / No of units produced 0.67 4.44 Frame Assembly Amount / No of units produced 0.44 1.78 Machine Related Amount / No of units produced 1.50 6.00 Total Overheads 4.11 28.56 Total Production Cost Material + Labour + Overheads 30.11 52.06 Answer (3) Calculation of profitability Standard Speciality Selling Price 36.00 50.00 Unit Product cost 30.11 52.06 Gross Margin per unit 5.89 -2.06 A look at the above profitability calcuation based on ABC system shows that speciality briefcase buiseness is actually losing money and the standard business is supporting the speciality briefcase business. A closure of standard briefcase production line and shifting the assets to speciality briefcase manufacture will result in a loss for the company Answer (4) The competition hasn't been able to touch the price of the company because it is selling at a price which is 4.12% lower than the unit product cost. As other competitiors are selling at cost plus profit basis, they would not be able to touch the price of Cases Inc. standard speciality total Units Produced per month 9000 2250 Material cost per suitcase Leather 15 7.5 Fabric 5 5 Synthetic 5 No of Units in each batch of production 200 25 Number of orders per month 75 225 300 No of Receipts per month 116 184 300 Number of setups per month Total Units / Units per bactch 45 90 Time required for setup number of hours 1 2 Total Numberof Setup hours required No of set ups * set up hours 45 180 225 Inspection time 300 500 800 Assembly Hours =total set up hours 800 800 1600 Machine time required per briefcase 0.5 2 Total machine hours required machine time * total units 4500 4500 9000
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