Reference no: EM131809332

Plum Electronics, a division of Berry Corporation, manufactures two large-screen television models: the Mammoth, which has been produced since 2009 and sells for $990, and the Maximum, a newer model introduced in early 2011 that sells for $1,254. Based on the following income statement for the year ended November 30, 2013, senior management at Berry have decided to concentrate Plum's marketing resources on the Maximum model and to begin to phase out the Mammoth model because Maximum generates a much bigger operating income per unit.

Plum Electronics Income Statement for the Fiscal Year Ended November 30, 2013
	Mammoth	Maximum	Total
Revenues	$21,780,000	$5,016,000	$26,796,000
Cost of goods sold	13,794,000	3,511,200	17,305,200
Gross margin	7,986,000	1,504,800	9,490,800
Selling and administrative expense	6,413,000	1,075,800	7,488,800
Operating income	$1,573,000	$429,000	$2,002,000
Units produced and sold	22,000	4,000
Operating income per unit sold	$71.50	$107.25

Details for cost of goods sold for Mammoth and Maximum are as follows:

a Mammoth requires 1.5 hours per unit and Maximum requires 3.5 hours per unit. The direct manufacturing labour cost is $13.20 per hour.

b Machine costs include lease costs of the machine, repairs, and maintenance. Mammoth requires 8 machine-hours per unit and Maximum requires 4 machine-hours per unit. The machine-hour rate is $19.80 per hour.

c Manufacturing overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.

Plum's controller, Steve Jacobs, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company's manufacturing overhead costs for the year ended November 30, 2013.

Units of the Cost-Allocation Base
Activity Centre (Cost-Allocation Base)	Total Activity Costs	Mammoth	Maximum	Total
Soldering (number of solder points)	$1,036,200	1,185,000	385,000	1,570,000
Shipments (number of shipments)	946,000	16,200	3,800	20,000
Quality control (number of inspections)	1,364,000	56,200	21,300	77,500
Purchase orders (number of orders)	1,045,440	80,100	109,980	190,080
Machine power (machine-hours)	63,360	176,000	16,000	192,000
Machine setups (number of setups)	825,000	16,000	14,000	30,000
Total manufacturing overhead	$5,280,000

After completing his analysis, Jacobs shows the results to Charles Clark, the Plum division president. Clark does not like what he sees. "If you show headquarters this analysis, they are going to ask us to phase out the Maximum line, which we have just introduced. This whole costing stuff has been a major problem for us. First Mammoth was not profitable and now Maximum. "Looking at the ABC analysis, I see two problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. Second, you used number of setups and number of inspections as allocation bases. The numbers would be different had you used setup-hours and inspection-hours instead. I know that measurement problems precluded you from using these other cost-allocation bases, but I believe you ought to make some adjustments to our current numbers to compensate for these issues. I know you can do better. We can't afford to phase out either product." Jacobs knows that his numbers are fairly accurate. As a quick check, he calculates the profitability of Maximum and Mammoth using more and different allocation bases. The set of activities and activity rates he had used results in numbers that closely approximate those based on more detailed analyses. He is confident that headquarters, knowing that Maximum was introduced only recently, will not ask Plum to phase it out. He is also aware that a sizable portion of Clark's bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, he feels some pressure from Clark to do something.

Questions:

What type of costing system are they currently using, what are the current cost allocation bases used for indirect costs and what are the consequences for the Maximum and Mammoth costs? What is the costing issue currently facing the company? What is the alternate costing system that is being proposed? Demonstrate the effect of the alternate costing system on the unit costs of the Maximum and the Mammoth using the example of calculations for allocating purchase order costs. What are the advantages of the alternate costing system? What is the potential ethical dilemma facing the management accountant in this scenario?