Reference no: EM131957745

Problem

Perkins Cove Yacht Company produces three models of yachts. All are 44 feet long. One is a standard Fiberglass model with nylon sails and a fixed keel made of lead and fiberglass named the Goose Rocks. It comes with a standard depth finder, compass and 20 horsepower diesel auxiliary motor. It sells for $120,000.

The Kennebunkport model has upgrades with radar, GPS nautical charts, enhanced batteries, and Teflon coated carbon fiber sails. The engine produces 100 horsepower and can run a cabin heater. It can completely recharge the battery in less than an hour. The Kennebunkport sells for $200,000.

The Ogunquit model is a custom-made with a deck made from teak and a cabin constructed from special woods. The sails are made from the traditional flax based canvass. The hull is from specially cut oak from local forests. It has the look of a vessel constructed in 1850 by a quality Maine shipyard with 2016 comforts and safety. The Ogunquit sells for $800,000. Workers who build the Ogunquit are specialty craftsmen. They earn twice the hourly rate of those working on the two standard models. Note: Labor rate is fully loaded for benefits.

Most of Perkins Cove Yacht's sales come from the Goose Rocks and the Kennebunkport, but sales of the Ogunquit model have been growing. Below is the company's sales, production, and cost information for last year:

Yacht	Goose Rocks	Kennebunkport	Ogunquit
Volume	50	100	20
Price	$120,000	$200,000	$800,000
Unit costs
Direct Materials	$30,000	$82,000	$250,000
Direct Labor	$36,000	$51,000	$440,000
Manufacturing Overhead*	$27,000	$27,000	$27,000
Total Unit Cost	$93,000	$160.000	$717,000
Unit Gross Profit	$27,000	$40,000	$83,000
Direct Labor Hours	1,000	1000	4750
Rate per Hour	$36.00	$51.00	$92.63

Manufacturing overhead* is made up as follows:

Depreciation	$2,200,000
Maintenance	$700,000
Purchasing	$180,000
Inspection	$350,000
Indirect Materials	$290,000
Supervision	$800,000
Supplies	$70,000
Total Manufacturing Overhead Cost	$4,590,000

*These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.

The company allocates overhead costs using the traditional method. Its activity base is unit volume. The predetermined overhead rate, based on 170 total yachts, is $27,000 per yacht ($4,590,000 ÷ 170 yachts). Richard Perkins, president of Perkins Cove yacht, is concerned that the traditional cost-allocation system the company is using may not be generating accurate information and that the selling price of the custom Ogunquit may not be covering its true cost.

Questions:

The cost-allocation system Perkins Cove has been using allocates over 88% of overhead costs to the Goose Rocks and the Kennebunk because 88% of yachts produced were these two models. How much overhead was allocated, in total, to each of the three models last year?

Discuss why this might not be an accurate way to assign overhead costs to products.

Perkins Cove's production manager proposes allocating overhead by direct labor hours instead since the different models require different amounts of labor. How much overhead would be allocated to each yacht (per unit and in total) under this method? Show all supporting calculations.

How would the use of more than one cost pool improve Perkins Cove Yacht's cost allocation?

Perkins Cove Yacht's controller developed the following data for use in activity-based costing:

Manufacturing Overhead	Amount	Cost Driver	Goose Rocks	Kennebunkport	Ogunquit
Depreciation	$2,200,000	Square Feet	20,000	30,000	30,000
Maintenance	$700,000	Direct Labor Hours	50,000	100,000	95,000
Purchasing	$180,000	# of Purchase Orders	1,500	1,500	6,000
Inspection	$350,000	# of Inspections	400	800	2,000
Indirect Materials	$290,000	Units Manufactured	50	100	20
Supervision	$800,000	# of Inspections	400	800	2.000
Supplies	$70,000	Units Manufactured	50	100	20
Total	$4,590,000

Use activity-based costing to allocate the costs of overhead per unit and in total to each yacht. Show all supporting calculations. It is appropriate to use an excel document to do your computations in Excel.

Calculate the cost of one custom Ogunquit yacht using activity-based costing.

Why are the costs different between the traditional method and the activity-based method?

At the current selling price, is the company covering its true cost of production of the Ogunquit? Briefly discuss.

What should be the price that Perkins Cove Yacht Company charges for the Ogunquit? Assume that the Ogunquit should have the same profit margin as the Kennebunkport. Show all calculations.

What should Perkins Cove Yacht Co. do if the quantity of the Ogunquit yachts sold at the new price falls to 10 per year?

What should Perkins Cove Yacht Co. do about the situation if the price of the Ogunquit cannot exceed $800,000?

At a selling price of $800,000 each, what is the breakeven unit volume for the Ogunquit?

What are the lessons learned from this case?