Harvey Company produces two models of blenders: the “Super Model” (priced at $400) and the “Special Model” (priced at $200). Recently, Harvey has been losing market share with its Spe-cial Model because of competitors offering blenders with the same quality and features but at a lower price. A careful market study revealed that if Harvey could reduce the price of its Special Model to $180, it would regain its former share of the market. Management, however, is con-vinced that any price reduction must be accompanied by a cost reduction of the same amount so that per-unit profitability is not affected. Earl Wise, company controller, has indicated that pooroverhead costing assignments may be distorting management’s view of each product’s cost and,therefore, the ability to know how to set selling prices. Earl has identified the following overheadactivities: machining, inspection, and rework. The three activities, their costs, and practicalcapacities are as follows: Activity Cost Practical CapacityMachining $5,400,000 90,000 machine hoursInspection 3,600,000 45,000 inspection hoursRework 1,800,000 45,000 rework hours The consumption patterns of the two products are as follows: Special SuperUnits 100,000 30,000Machine hours 50,000 40,000Inspection hours 10,000 35,000Rework hours 7,500 37,500 Harvey assigns overhead costs to the two products using a plantwide rate based on machinehours.Required: 1. Calculate the unit overhead cost of the Special Model using machine hours to assign over head costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Harvey’s competitive problem? What did it reveal?2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higher quality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.
Harvey Company produces two models of blenders: the “Super Model” (priced at $400) and the
“Special Model” (priced at $200). Recently, Harvey has been losing market share with its Spe-
cial Model because of competitors offering blenders with the same quality and features but at a
lower price. A careful market study revealed that if Harvey could reduce the price of its Special
Model to $180, it would regain its former share of the market. Management, however, is con-
vinced that any price reduction must be accompanied by a cost reduction of the same amount so
that per-unit profitability is not affected. Earl Wise, company controller, has indicated that poor
therefore, the ability to know how to set selling prices. Earl has identified the following overhead
activities: machining, inspection, and rework. The three activities, their costs, and practical
capacities are as follows:
Activity Cost Practical Capacity
Machining $5,400,000 90,000 machine hours
Inspection 3,600,000 45,000 inspection hours
Rework 1,800,000 45,000 rework hours
The consumption patterns of the two products are as follows:
Special Super
Units 100,000 30,000
Machine hours 50,000 40,000
Inspection hours 10,000 35,000
Rework hours 7,500 37,500
Harvey assigns overhead costs to the two products using a plantwide rate based on machine
hours.
Required:
1. Calculate the unit overhead cost of the Special Model using machine hours to assign over head costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Harvey’s competitive problem? What did it reveal?
2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higher quality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.
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