Reference no: EM133150285

Question - A firm manufactures two models of a ball - a normal and a big model. The big model, introduced just two years ago, has been very successful. It now accounts for more than the half of the firm´s profits as an evidence by following income statement for 2021:

Its manufacturing plant in Ballland has two production departments - a machining department and an assembly department. The cost of good sold included $720 000 in production support costs. The plans accountant traces $192 000 of the production support costs to the machining department and $168 000 to the assembly department. The balance of $360 000 was allocated to the machining and the assembly departments in the proportion of their respective machine hours. Next, separate cost drivers were determined for the two production departments based on their respective direct labour hours to assign the support costs to the two products.

Total Direct Labor and Machine Hours

The direct labor wage is $10.00 per hour. Direct materials cost is $0.80 per unit for Normal and for the Big is $1.10 per unit. An average customer order for the Normal is for 5000, but for the Big model, each order is for 2000 units. The machines require a setup for each order. Three hours are required per machine setup for the Normal model; the more complex Big model requires five hours per setup.

The firms´ profitability has been declining for the past two years despite the successful launch of the Big model, which has now captured over a 65% share of its segment of the industry. Market share for the Normal model has decreased to 12%. In an endeavor to understand the reasons for its declining profitability, the company has appointed a special task force.

The task force is considering a new cost accounting system based on activity analysis. This system employs four cost drivers: two departmental direct labor hours, setup hours, and number of orders. Production support costs are traced to four homogenous cost pools, each identified with a unique driver as presented in the following table.

Trecable number of units of cost drivers

The task force also analyzed selling and administrative expenses. These costs included 5% sales commission on Normal and 10% on Big. Advertising and promotion expenses were $50,000 for Normal and $90,000 for Big. The remaining $180,000 of selling and administrative expenses was attributed equally to the two products.

a) Determine the product costs per unit using the existing cost accounting system. Show as clearly as possible all the intermediate steps for allocations, including departmental cost driver (allocation base) rates and a breakdown of product costs into each of their components.

b) Determine the product costs and profits per unit using the new activity-based costing system.

Show as clearly as possible all the intermediate steps, including the cost driver rates and components of product costs.

Specify all the assumptions you make.

Why do you think the firm uses the number of setup hours [instead of the number of setups] as the cost driver measure for the machine setup activity?

c) Explain the principal reasons that the old cost accounting system at the Firm may be distorting its product costs and profitability.

Support your answer with numbers when necessary.

d) Discuss, in great detail, to what extent the new cost accounting system at the Firm may be characterized as an ABC system.

e) Analyze the profitability of the two products.

What insight is provided by the new profitability analysis? What should The firm do to enhance its profitability? What options may be available?

f) Jonas is a marketing manager with considerable experience as a salesperson. Discuss how he is likely to react to your analysis and recommendations.