After her meeting with Joseph, Patty requested an investigation of the production costs and comparative efficiency. She received approval to hire a consulting group to make an independent investigation. After a three-month assessment, the consulting group provided the following in- formation on the plant's production activities and costs associated with the two products: Part #127 Part #234 500,000 $31.86 Production 100,000 Selling price Overhead per unit* Prime cost per unit Number of production runs Receiving orders S24.00 $12.83 S8.53 $5.77 $6.26 100 200 400 1,000 Machine hours 125,000 60,000 Direct labor hours 250,000 5,000 22,500 5,000 Engineering hours Material moves 500 400 * Calculated using a plantwide rate based on direct labor hours. This is the current way of assigning the plant's overhead to its products. The consulting group recommended switching the overhead assignment to an activity-based approach. It maintained that activity-based cost assignment is more accurate and will provide better information for decision making. To facilitate this recommendation, it grouped the plant's activities into homogeneous sets with the following costs: Overhead: Setup costs Machine costs $ 240,000 1,750,000 Receiving costs Engineering costs Materials-handling costs Total 2,100,000 2,000,000 900,000 $6,990,000
Product-Costing Accuracy, Corporate Strategy, ABC
Autotech Manufacturing is engaged in the production of replacement parts for automobiles.
One plant specializes in the production of two parts: Part #127 and Part #234. Part #127 pro-
duced the highest volume of activity, and for many years it was the only part produced by the
plant. Five years ago, Part #234 was added. Part #234 was more difficult to manufacture and
required special tooling and setups. Profits increased for the first three years after the addition of
the new product. In the last two years, however, the plant faced intense competition, and its sales
of Part #127 dropped. In fact, the plant showed a small loss in the most recent reporting period.
Much of the competition was from foreign sources, and the plant manager was convinced that
the foreign producers were guilty of selling the part below the cost of producing it. The following
conversation between Patty Goodson, plant manager, and Joseph Fielding, divisional marketing
manager, reflects the concerns of the division about the future of the plant and its products.
JOSEPH: You know, Patty, the divisional manager is real concerned about the plant’s trend. He indicated that in this budgetary environment, we can’t afford to carry plants that don’t show
a profit. We shut one down just last month because it couldn’t handle the competition.
PATTY: Joe, you and I both know that Part #127 has a reputation for quality and value. It has
been a mainstay for years. I don’t understand what’s happening.
JOSEPH: I just received a call from one of our major customers concerning Part #127. He said
that a sales representative from another firm offered the part at $20 per unit—$11 less than what
we charge. It’s hard to compete with a price like that. Perhaps the plant is simply obsolete.
PATTY: No. I don’t buy that. From my sources, I know we have good technology. We are effi-
cient. And it’s costing a little more than $21 to produce that part. I don’t see how these compa-
nies can afford to sell it so cheaply. I’m not convinced that we should meet the price. Perhaps a
better strategy is to emphasize producing and selling more of Part #234. Our margin is high on
this product, and we have virtually no competition for it.
JOSEPH: You may be right. I think we can increase the price significantly and not lose busi-
ness. I called a few customers to see how they would react to a 25 percent increase in price, and
they all said that they would still purchase the same quantity as before.
PATTY: It sounds promising. However, before we make a major commitment to Part #234, I think
we had better explore other possible explanations. I want to know how our production costs compare
to those of our competitors. Perhaps we could be more efficient and find a way to earn our normal
return on Part #127. The market is so much bigger for this part. I’m not sure we can survive with only
Part #234. Besides, my production people hate that part. It’s very difficult to produce.
Required:
1. Verify the
to assign overhead. Compute the per-unit gross margin for each product.
2. After learning of activity-based costing, Patty asked the controller to compute the product
cost using this approach. Recompute the unit cost of each product using activity-based cost-
ing. Compute the per-unit gross margin for each product.
3. Should the company switch its emphasis from the high-volume product to the low-volume
product? Comment on the validity of the plant manager’s concern that competitors are sell-
ing below the cost of making Part #127.
4. Explain the apparent lack of competition for Part #234. Comment also on the willingness
of customers to accept a 25 percent increase in price for Part #234.
5. Assume that you are the manager of the plant. Describe what actions you would take based
on the information provided by the activity-based unit costs.
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