Cornerstones of Cost Management Study Set 4

Business

Quiz 21 :
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Quiz 21 :
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Compute two different unit costs for each of the Cable Service Division's products. What managerial objectives are being served by these unit cost computations?
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Answer:

Answer:

Plant wide rates:
It is a pre-determined overhead rate which is used to allocate the overhead costs to actual units produced. It is calculated using the budgeted overhead and budgeted cost driver. The cost driver usually is the budgeted direct labor hours.
Applied overhead:
The total overhead allocated to actual production is called the applied overhead.
Unit overhead cost:
The overhead applied to actual production divided by the number of units produced is the overhead cost per unit.
1.Calculate the pre-determined plant wide overhead rate and the applied overhead for each product using direct labor hours as the cost driver:
Calculate the pre-determined overhead rate as shown below:
It is calculated by dividing estimated overhead by the expected level of activity (direct labor hours).
img Therefore, the pre-determined plant wide overhead rate is
img Calculate the applied overhead for products deluxe speaker and regular speaker as shown below:
It is calculated by applying pre-determined plant wide overhead rate per hour to the direct labor hours spent in producing the product.
Overhead applied to deluxe speaker is
img Therefore, overhead applied to deluxe speaker is
img Overhead applied to regular speaker is
img Therefore, overhead applied to regular speaker is
img 2.Calculate the overhead cost per unit of each product:
Overhead cost per unit is calculated by dividing the overhead applied to the product by the number of units actually produced.
Calculate the overhead cost per unit of deluxe speaker as shown below:
img Therefore, overhead cost per unit of deluxe speaker is
img Calculate the overhead cost per unit of regular speaker as shown below:
img Therefore, overhead cost per unit of deluxe speaker is
img Calculate the effect on the profitability if 10,000 hours were used instead of 5,000 hours of deluxe speaker:
Calculate the effect on profitability as shown below:
In case of additional labor hours spent the profit will decrease to the extent of additional overhead incurred which is
img Therefore, the additional overhead applied is
img Therefore, the profit will decrease to the extent of
img

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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Three different cost categories are provided by the Cable Service Division: direct tracing, driver tracing, and allocation. Discuss the meaning of each. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based cost accounting system? What other differences exist between functional-based and activity-based cost accounting systems?
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Essay
Answer:

Answer:

Direct tracing:
Direct tracing is a process of determining costs associated to direct materials. Costs for whole direct operations are determined in total thereby knowing the profitability of the production concerned with different product lines.
Driver tracing:
Driver tracing is a process of determining costs associated to any particular cost driver. A cost for each driver is determined separately, thereby knowing the costs associated with each cost driver.
Allocation:
Allocation refers to the process of assigning costs to each operation and each material concerned with a specific operation in order to determine the total costs and cost per unit of the production.
C S Division uses activity based cost accounting system.
The major difference between functional based and activity based cost accounting is that under functional approach costs are assigned to each functional division concerned with production. While in case of activity based costing costs are assigned to per activity performed for producing a product.

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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Discuss the differences between the Cable Service Division's products and the Phone Division's products.
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Essay
Answer:

Answer:

The differences between the C S Division's products and P Division's products are as under:
1. The P Division is concerned with manufacturing telephones in different segments. Therefore it is dealing in physical production of goods. While C S Division is concerned with telecasting different channels, thus it is providing service to customers.
2. As P Division is associated with physical production, so its products are tangible in nature. While as C S Division is a service industry, hence its production is intangible.
3. The P Division manufactures its products in Midwest and C S Division is providing its cable service in Ohio.
4. Because of high quality and advanced input usage P Division's products are expensive. But C S Division provides service at reasonably low price.
5. A single product is manufactured by P Division that is telephone. But C S Division offers three products to customers, basic channel package, enhanced package and a premium package of 25 plus 2 more channels.

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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Prepare an income statement for the Cable Service Division for March.
Essay
Answer:
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Prepare an income statement for the Phone Division for March. Include a supporting cost of goods manufactured statement.
Essay
Answer:
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required The Phone Division has been using the same cost accounting system for over 10 years. Explain why its cost accounting system may be outmoded. What factors determine when a new cost accounting system is warranted?
Essay
Answer:
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Using the method of least squares, calculate two cost formulas: one for overhead using direct labor cost as the driver, and one for materials handling cost using number of moves as the driver. Comment on Jacob Carder's observations concerning the outcomes.
Essay
Answer:
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required How would you describe the cost behavior of the inspection activity? Assume that the quality control manager implements a program that reduces the number of defective units by 50 percent. Because of the improved quality, the demand for inspection hours will also drop by 50 percent. What is the potential monthly reduction in inspection costs? How did knowledge of inspection's cost behavior help?
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Calulate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products.
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Calculate the overhead cost per unit using the four activities and drivers identified by Kim and Jacob. If you were Kim, would you be inclined to implement an ABC system based on the evidence from this pilot test?
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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 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: img 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: img img 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. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices." Larry: "They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regain most ofour 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 overcosted, 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." img 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: img 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: img 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 overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well-enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. 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: img Expected activity demands: img Required Suppose someone urged Kim to look into Time-Driven Activity-Based Costing (TDABC) instead of ABC. What would be the advantages of using a TDABC aproach?
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Allocate the joint manufacturing costs to each grade, and calculate the cost per board foot for each grade: (a) using the physical units method of allocation, and (b) using the sales-value-at- split-off method. Which method should the mill use? Explain. What is the effect on the cost of each proposed job if the mill switches to the sales-value-at-split-off method?
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Calculate the plantwide overhead rate for the fabric plant.
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Calculate the amount of under- or overapplied overhead for the fabric plant.
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Using the weighted average method, calculate the cost per bolt for Fabric FB70.
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Assume that the weaving and pattern process is not a separate process for each fabric. Also, assume that the yarn used for each fabric differs significantly in cost. In this case, would process costing be appropriate for the weaving and pattern process? What costing approach would you recommend? Describe your approach in detail.
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required In the Coloring and Bolting Department, 400,000 ounces of other materials were used to produce the output of the period. Using the proposed standard cost sheet, calculate the following variances for the Coloring and Bolting Department: a. Materials price variance (for other materials only) b. Materials usage variance (for other materials only) c. Labor rate variance d. Labor efficiency variance In calculating the variances, which method did you use to compute the actual output of the period-FIFO or weighted average? Explain.
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Assume that the standard hours allowed for the actual total output of the fabric plant are 115,000. Calculate the following variances: a. Fixed overhead spending variance b. Fixed overhead volume variance c. Variable overhead spending variance d. Variable overhead efficiency variance
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Suppose that the fabric plant has 500 bolts of FB70 in beginning finished goods inventory. The current-year plan is to have 1,000 bolts of FB70 in finished goods inventory at the end of the year. This fabric has an external market price of $400 per bolt. If the fabric plant is set up as a profit center, it could sell 3,000 bolts per year to outside customers and supply 2,000 bolts per year internally to Beauville's furniture plant. If the fabric plant were designated as a profit center, the plant would transfer all goods internally at market price. Using the proposed standard cost sheet (as needed) and any other relevant data, prepare the following for Fabric FB70: a. Sales budget b. Production budget c. Direct labor budget d. Cost of goods sold budget
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Beauville Furniture Corporation produces sofas, recliners, and lounge chairs. Beauville is located in a medium-sized community in the southeastern part of the United States. It is a major employer in the community. In fact, the economic well-being of the community is tied very strongly to Beauville. Beauville operates a sawmill, a fabric plant, and a furniture plant in the same community. The sawmill buys logs from independent producers. The sawmill then processes the logs into four grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although no outside sales exist, the mill could sell to external customers, and the selling prices of the four grades are known. The fabric plant is responsible for producing the fabric that is used by the furniture plant. To produce three totally different fabrics (identified by fabric ID codes FB60, FB70, and FB80, respectively), the plant has three separate production operations-one for each fabric. Thus, production of all three fabrics occurs at the same time in different locations in the plant. Each fabric's production operation has two processes: the weaving and pattern process and the coloring and bolting process. In the weaving and pattern process, yarn is used to create yards of fabric with different designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant's Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant. The furniture plant produces orders for customers on a special-order basis. The customers specify the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500 units). The plant has two production departments: Cutting and Assembly. In the Cutting Department, the fabric and wooden frame components are sized and cut. Other components are purchased from external suppliers and are removed from stores as needed for assembly. After the fabric and wooden components are finished for the entire job, they are moved to the Assembly Department. The Assembly Department takes the individual components and assembles the sofas (or chairs). Beauville Furniture has been in business for over two decades and has a good reputation. However, during the past five years, Beauville experienced eroding profits and declining sales. Bids were increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning bids on some of the more-difficult-to-produce items. Lance Hays, the owner and manager, was frustrated. He simply couldn't understand how some of his competitors could sell for such low prices. On a common sofa job involving 500 units, Beauville's bids were running $25 per unit, or $12,500 per job more than the winning bids (on average). Yet, on the more difficult items, Beauville's bids were running about $60 per unit less than the next closest bid. Gisela Berling, vice president of finance, was assigned the task of preparing a cost analysis of the company's product lines. Lance wanted to know if the company's costs were excessive. Perhaps the company was being wasteful, and it was simply costing more to produce furniture than it was costing its competitors. Gisela prepared herself by reading recent literature on cost management and product costing and attending several conferences that explored the same issues. She then reviewed the costing procedures of the company's mill and two plants and did a preliminary assessment of their soundness. The production costs of the mill were common to all lumber grades and were assigned using the physical units method. Since the output and production costs were fairly uniform throughout the year, the mill used an actual costing system. Although Gisela had no difficulty with actual costing, she decided to explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the mill were gathered so that an analysis could be conducted. The two plants used normal costing systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in the plant's overhead cost could be explained by direct labor hours. Thus, the use of a plantwide overhead rate based on direct labor hours seemed justified. What did concern her, though, was the material waste that she observed in the plant. Maybe a standard cost system would be useful for increasing the overall cost efficiency of the plant. Consequently, as part of her report to Lance, she decided to include a description of the fabric plant's costing procedures-at least for one of the fabric types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant, however, was a more difficult matter. Product diversity was present and could be causing some distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the variability in overhead cost was explained by the direct labor hours. She decided that additional analysis was needed so that a sound product costing method could be recommended. One possibility would be to increase the number of overhead rates. Thus, she decided to include departmental data so that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore the possibility of converting the sawmill and fabric plant into profit centers and changing the existing transfer pricing policy. With the cooperation of the cost accounting manager for the mill and each plant's controller, she gathered the following data for last year: Sawmill: Joint manufacturing costs: $900,000 img Fabric Plant: Budgeted overhead: $1,200,000 (50% fixed) Practical volume (direct labor hours): 120,000 hours Actual overhead: $1,150,000 (50% fixed) Actual hours worked: img Departmental data on Fabric FB70 (actual costs and actual outcomes): img img *Unitsare measured in yards for the Weaving and Pattern Department and in bolts forthe Coloring and Bolting Department. Note: With the exception of the cardboard bolt rods, materials are added at the beginning of each process. The cost of the rods is relatively insignificant and is included in overhead. Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only): img Furniture Plant: Departmental data (budgeted): img After some discussion with the furniture plant controller, Gisela decided to use machine hours to calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly Department rate (the Cutting Department was more automated than the Assembly Department). As part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the company was experiencing. To assess the effect of the different overhead assignment procedures, Gisela decided to examine two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style and Fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the costs of the two jobs, Gisela assembled the following information on the two jobs: Job A500: img Job B75: img Required Calculate the following overhead rates for the furniture plant: (1) plantwide rate and (2) departmental rates. Use the direct method for assigning service costs to producing departments.
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