Reference no: EM132908515

Question - Kumar Boats Limited manufactures and sells fishing boats. All of the company's sales come from two products: the Hauler and the Deluxe. The Hauler is a basic boat built with the minimum required components necessary for a successful outing and sells for $24,000. The Deluxe includes additional features unavailable on the Hauler, such as adjustable padded seats, moveable storage boxes, and rod holders, and sells for $29,000. The boats are sold to retailers who then usually add an outboard motor and a trailer before selling to the consumer.

Kumar Boats Limited management is meeting to discuss recent financial results and to plan for the future. Richard Rajan, the sales manager, advocates for keeping the prices of the two boats close in price since they share many similar features (e.g., size and weight, seating capacity, etc.). Mary Borkowski, the CEO of Kumar Boats, is concerned and has reviewed the financial information for both product lines. She has noticed that sales volume has been increasing while profits (as a percentage of sales) are decreasing. Mary consulted with her production manager, Craig Steele, who informed her that he is doing his best to control costs but it is difficult since the proportion of the Deluxe boats being manufactured and sold is growing at a much faster rate than sales of the Hauler.

Mary has asked the CFO for more detailed financial information regarding the sales and manufacturing costs of each product line for the past year. The following information was provided to Mary.

	Hauler	Deluxe
Direct materials cost per unit	$12,300	$16,400
Direct labour hours per unit	89	116
Units sold	245	134

Manufacturing overhead in the past year was $887,200.

In the existing system, manufacturing overhead is applied on the basis of direct labour hours.

The total direct labour hours for the past year were 22,180.

The hourly rate for direct labour hours is $33.

Selling and administrative costs for the past year was $1,468,000.

To help Mary gain a better understanding of the costs of operations, she asked the CFO to provide her with information regarding the company's activities for the past year. Using an activity-based costing (ABC) approach, the CFO gathered the following information:

Activity Centre Cost Driver Activity Cost Activity Volume

Materials handling Number of material moves $210,800 5,270 moves

Equipment setup Number of setups $258,800 1,294 setups

Testing Number of testing hours $168,000 1,500 testing hours

Purchasing raw materials Number of purchase orders $249,600 2,600 purchase orders

Financial data for the two products, based on ABC analysis, is as follows:

	Hauler	Deluxe
Direct materials cost per unit	$12,300	$16,400
Direct labour hours per unit	89	116
Materials handling movements	4	32
Number of setups	2	12
Testing hours	2	14
Purchase orders required	3	15
Units sold	245	134

Required -

(A) Compute unit cost using the existing costing system (i.e., using a single, plantwide rate to apply overhead costs). Compute gross and net operating income generated for the company by the two products.

(B) Compute activity rates, rounding to the nearest dollar.

(C) Compute unit cost using activity-based costing and recompute gross and net operating income generated by the two products.

(D) Based on the results above, what advice would you give to Mary regarding her observation of increasing sales volume but decreasing profit?