5-52 Volume-based Costing Versus ABC
1.
Product A
(1) Target price
$279.00
(2) Manufacturing cost (1) ÷ 150% $186.00
Prime cost
- 70.00
Overhead cost per unit
$116.00
Number of units
x 1,000
Total overhead
$116,000
Product B
$294.00
$196.00
- 126.40
$ 69.60
x 5,000
$348,000
Product C
$199.50
$133.00
- 75.00
$ 58.00
x
500
$29,000
2. Current Costing system
Actual selling price
Product manufacturing cost
Gross margin
Gross margin ratio
Product A
$280
186
$ 94
33.57%
Product B
$250
196
$ 54
21.6%
Product C
$300
133
$167
55.67%
Based on the current cost data, it is true that product B is the least
profitable product with a gross margin per unit of $54.00 (21.6%) and
product C is the most profitable product with a gross margin per unit of
$167.00 (55.67%). However, the validity of this conclusion is based on
the accuracy of the reported product costs.
Product costs based on the activity-based costing system
Direct materials
Direct labor
Factory overhead:
Setups (a)
Materials handling (b)
Hazardous control (c)
Quality control (d)
Utilities (e)
Total
Actual selling price
Product manufacturing cost
Gross margin
Gross margin ratio
Product A
$ 50.00
20.00
Product B
$114.40
12.00
Product C
$ 65.00
10.00
1.60
40.00
62.50
22.50
12.00
$208.60
0.80
5.00
22.50
5.25
8.40
$168.35
4.80
70.00
150.00
52.50
12.00
$364.30
$280.00
208.60
$ 71.40
25.50%
$250.00
168.35
$ 81.65
32.66%
$300.00
364.30
($64.30)
(21.43)%
1
5-52 (continued)
Notes:
(a) Setups:
Cost per setup: $8,000 / (2 + 5 + 3) =
$800 per setup
Product A = 2 x $800 = $1,600;
$1,600 /1,000 = $1.60 per unit
Product B = 5 x $800 = $4,000;
$4,000 /5,000 = $0.80 per unit
Product C = 3 x $800 = $2,400;
$2,400 /500 = $4.80 per unit
(b) Materials handling:
Cost per pound = $100,000 / (400 + 250 + 350) = $100 per pound
Product A = 400 x $100 = $40,000; $40,000/1,000 = $40.00 per unit
Product B = 250 x $100 = $25,000; $25,000/5,000 = $ 5.00 per unit
Product C = 350 x $100 = $35,000; $35,000/500 = $70.00 per unit
(c) Waste and hazardous disposals:
Cost per disposal: $250,000/(25 + 45 + 30) = $2,500 per disposal
Product A = 25 x $2,500 = $ 62,500; $ 62,500/1,000 = $ 62.50/unit
Product B = 45 x $2,500 = $112,500; $112,500/5,000 = $ 22.50/unit
Product C = 30 x $2,500 = $ 75,000; $ 75,000/500 = $150.00/unit
(d) Quality inspections:
Cost per inspection = $75,000/(30 + 35 + 35) = $750 per inspection
Product A = 30 x $750 = $22,500; $22,500/1,000 = $22.50 per unit
Product B = 35 x $750 = $26,250; $26,250/5,000 = $ 5.25 per unit
Product C = 35 x $750 = $26,250; $26,250/500 = $52.50 per unit
(e) Utilities:
Cost per MH = $60,000 / (2,000 + 7,000 + 1,000) = $6.00 per MH
Product A = 2,000 x $6 = $12,000; $12,000/1,000 = $12.00 per unit
Product B = 7,000 x $6 = $42,000; $42,000/5,000 = $ 8.40 per unit
Product C = 1,000 x $6 = $ 6,000; $ 6,000/500 = $12.00 per unit
2
5-52 (continued-2)
3. Comparison of reported product costs, new target price, actual selling
price, and gross margin (loss):
Product A Product B Product C
Product costs:
1. Direct-labor based system
$186.00
$196.00
$133.00
2. Activity-based system
$208.60
$168.35
$364.30
ABC-based product costs:
Target price (150%)
Actual selling price
Difference in price
$312.90
$252.53
$280.00
$250.00
<$32.90>
<$2.53>
$546.45
$300.00
<$246.45>
Direct-labor based costing system
Gross margin
Gross margin ratio
$ 94
33.57%
$ 54
21.6%
$167
55.67%
Activity-based costing system:
Gross margin
Gross margin ratio
$71.40
25.50%
$81.65
32.66%
$(64.30)
<21.43%>
4. Strategic and Competitive Analysis
1. Emphasizing Product C as suggested by the current directlabor-cost based overhead costing system is likely to harm
the firm’s competitiveness. The activity-based costing
system shows that the manufacturing cost of Product C is
$364.30 per unit and, at the current selling price, the firm
suffers a $64.30 loss for each unit it manufactures and sells.
2. If the actual selling prices of products A & B are fair market
prices for these products and a markup of 150% is a
common industry practice, the firm needs to examine the
manufacturing cost of product A. The fact that the firm’s
target price, determined using 150% of the manufacturing
cost, is more than 10 percent over the fair market price of
the product suggests possible wastes and inefficiencies in
the manufacturing of product A.
3
5-54
Volume-Based Costing Versus ABC
1. Current costing system (direct-labor hour)
Deluxe
%
Speedy
Price
$475 100
$300.00
Prime Cost
180
38
110.00
Overhead
20
4
153.60
Unit gross profit
$275
58
$ 36.40
%
100
37
51
12
2. Multiple drivers costing system
Calculation of unit overhead costs - Deluxe:
Setups
Machine costs
Engineering
Packing
Total overhead
Number of Units
Overhead per unit
$2,800 x
200 =
$100 x 100,000 =
$40 x 45,000 =
$20 x 50,000 =
Deluxe
$ 560,000
10,000,000
1,800,000
1,000,000
$13,360,000
÷
50,000
$267.20
Calculation of unit overhead costs - Speedy:
Setups
Machine costs
Engineering
Packing
Total overhead
Number of Units
Overhead per unit
$2,800 x
100 =
$100 x 400,000 =
$40 x 120,000 =
$20 x 200,000 =
Price
Cost
Prime cost
$180.00
Overhead
267.20
Unit gross profit
Speedy
$ 280,000
40,000,000
4,800,000
4,000,000
$49,080,000
÷
400,000
$122.70
Deluxe %
$475.00 100
447.20
$27.80
4
94
6
$110.00
122.70
Speedy
$300.00
%
100
232.70
$67.30
78
22
5-54 (continued)
3. Using the activity-based costing, a much different picture on profitability
of the Deluxe and Speedy models emerges. The Speedy model is
actually more profitable than the Deluxe model. The revised cost data
suggests that shifting the emphasis to the Deluxe model may very well
be a mistake. The Deluxe printer is a much heavier user of overhead
resources as can be seen in the table below that compares uses of
overhead.
Overhead
Activity
Activity Consumption
Deluxe
Speedy
Setups
Machine costs
Engineering
Packing
250 units per setup
4,000 units per setup
2 MH per unit
1 MH per unit
0.9 Engr. Hr. per unit
1 unit per packing order
0.3 Engr. Hr. per unit
2 units per packing order
Supporting calculations
Activity Consumption
Deluxe
Total Per Activity Measure
Units
Setups
Machine
costs
50,000
400,000
200 250 units per setup
100,000
2 MH per unit
Engineering 45,000 0.9 Engineering
Hours per unit
Packing
50,000
Speedy
Total Per Activity Measure
100 4,000 units per setup
400,000 1 MH per unit
120,000 0.3 Engineering
hours per unit
1 unit per packing 200,000
order
2 units per packing
order
4. The ABC method is likely to provide Gorden Company a more accurate
product cost picture. It also directs the management’s attention to the
high volume, more profitable Speedy printers.
Given the low profit margin of the Deluxe, the firm may want to
investigate the feasibility of raising the price, the possibility of reducing
product cost, or both.
5