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This case was prepared by Kristy Lilly (MBA 03) and Liz Smith (MBA 04), under the supervision of Professor
Mark Haskins. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling
of an administrative situation. Copyright 2003 by the University of Virginia Darden School Foundation,
Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing.com. No part
of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any
form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of
the Darden School Foundation.


ZAUNER ORNAMENTS


As she put the finishing touches on the annual financial statements for Zauner
Ornaments, Chia-yi Yu contemplated her schedule for the next few weeks. As the new
controller for Zauner Ornaments in Taiwan, Yu thought the slow-sales period in January would
be the perfect time for her to focus on Zauners management-accounting procedures. Yu had
recently returned to Taiwan from graduate business school in Europe, and she was anxious to
apply the knowledge she had gained at school to her new job. As a first step, Yu decided to
research Zauners current costing methods.


Background

Zauner Ornaments was a wholly owned subsidiary of Zauner Crystal, Inc., a large
manufacturer of crystal and glass products headquartered in Vienna, Austria. Although
originally established as an industrial-glass producer, Zauner Crystal reinvented itself after the
Second World War as a producer of fine crystal, glass tableware, and other similar products.
The company enjoyed an international reputation as a producer of high-quality glass and crystal
at affordable prices owing to the skills of its master artisans, as well as the application of
innovative technology in the manufacturing process. Zauner crystal was used in fine restaurants,
hotels, and residences throughout the world.


Zauner Ornaments

Several years previously, management at Zauner Crystal recognized that growth in the
fine-crystal and glass-tableware markets was beginning to slow, forcing the company to search
for other growth opportunities. After extensive research, management concluded that expanding
into glass Christmas-tree ornaments would allow the company not only to continue to grow, but
also to take advantage of Zauner Crystals unique capabilities. The company leased a small
manufacturing facility in Taiwan, and began producing the following three products there:


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Ornaments Sales Price
per Box per Box*
Small glass ball ornaments 12 $9.00
Large glass ball ornaments 6 $11.00
Specialty glass ball ornaments 1 $17.00

*Note: All monetary amounts are expressed in U.S. dollars


Cost Accounting at Zauner Ornaments

In the third week of January, Yu called the sales department to inquire about price-setting
procedures for the different product lines. She quickly discovered that the sales department
investigated the prices of similar products available in the marketplace and set Zauners prices
accordingly. Yu knew that the company was profitable overall, but wondered if the prices set by
the sales department were sufficient to ensure that the individual product lines were profitable.
She decided to have one of her senior analysts, Yung Chen, prepare an analysis of unit-product
costs for each of Zauners three products. She thought this might be helpful in determining
whether any adjustments in the product prices were warranted. To assist Chen in his task, Yu
provided him with a schedule of the factorys annual overhead costs, as follows:

Overhead Item Annual Cost

Production scheduling $ 85,000
Machine setups 160,000
Equipment depreciation 220,000
Plant depreciation 150,000
Quality inspection 70,000
Packing 185,000
Plant administration 300,000

Total overhead $1,170,000

Later that day, Chen returned to Yus office with a schedule showing his calculation of
product costs for each of Zauners three products (Exhibit 1). Chen calculated the cost per box
for each product, using a traditional volume-based costing system. Budgeted overhead was
allocated to each product line, based on the planned production of ornaments. Chen and Yu were
dismayed by the results of Chens analysis; according to his calculations, Zauner was selling
small glass ornaments for $9.00 a box, but it was costing the company $21.12 a box to produce
those ornaments!

Yu took these results to the director of Operations, David Metz. Im really worried
about our pricing and the efficiency of our manufacturing processes, Yu told Metz. According
to this product-cost analysis, we are losing money on both the small and large glass ornaments

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we produce, while making money on the specialty ornaments. Surely, that cant be the case, can
it? Are our costs really that much higher than other firms in the industry? Metz looked at
Chens schedule and shook his head. I think I see the problem here, he told Yu. Youve
allocated overhead to each product, using production units. Why dont you try this analysis
again, this time allocating overhead to each product based upon direct materials and direct labor?
I think that method better approximates the actual use of the overhead resource by each product
line, and it should fix your problem.

Yu returned to her office and instructed Chen to redo his analysis using direct materials
plus direct labor as the allocation base for overhead expenses. Chen soon returned with the
product-cost schedule shown in Exhibit 2. Look! he told Yu. I think Metz was correct.
Allocating overhead based on direct materials and direct labor gives us product costs that are
below our current sales price for each product line. I think were fine now.

Yu felt better after seeing Chens second analysis, but she was not fully convinced that
the revised schedule captured Zauners product costs in the most accurate manner. While Chen
was working on his analysis, Yu met with the manufacturing department to gain a better
understanding of Zauners operations. The results of these meetings are summarized in Exhibit
3. She learned that, while all three ornaments were made on the same production lines, specialty
ornaments underwent an additional painting process. In the specialty-painting department, 24
fully utilized workers hand-painted intricate designs on the inside of each specialty ornament.
Yu also discussed with Manufacturing the types of overhead at Zauner and the specific activities
that could be generating the companys overhead costs. She discovered that both production-
scheduling and machine-setup costs appeared to be driven primarily by the number of batches
required for the annual production volume. Because the number of batches varied by product
type, Yu concluded that total yearly batches might be an appropriate means of allocating
production-scheduling and machine-setup costs to the different product lines.

In addition, she had a little more difficulty ascertaining the root cause of equipment
depreciation. It was unclear whether equipment depreciation occurred because of the number of
machine operations performed or because of the machine run time. Based on feedback from the
manufacturing department, she decided that the number of machine operations was the better
indicator of equipment depreciation. She also thought that plant depreciation could reasonably
be based on the factory square footage used to manufacture, paint, and store each box. Her
discussions also led her to conclude that the number of inspections performed drove inspection
costs, while the number of boxes used drove packaging costs. Plant administration (which
included supervision, labor relations, and clerical costs) appeared to be the most problematic in
deciding how best to allocate these costs. Yu would have to make that decision soon, and in the
meantime, had gathered the data in Exhibits 4 and 5, which she thought might be useful in her
deliberations.

After seeing Zauners manufacturing process, Yu recalled reading about activity-based
costing (ABC) in graduate school. She remembered that companies used ABC systems to assign

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indirect manufacturing costs to products based on the activities performed on those products. Yu
thought she might be able to use ABC to reflect Zauners product costs more accurately, thereby
improving product-pricing decisions.


Assignment Questions

1. Determine the best base for allocating plant-administration costs.

2. Calculate the ABC costs for each product on a per-box basis.

3. What do these results tell you about activity-based costing versus costing based on
standard volume or direct materials plus direct labor?

4. What changes, if any, should management make to Zauners pricing strategy?



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Exhibit 1

ZAUNER ORNAMENTS

Calculation of Product Costs: Volume-Based Costing System




Number of Ornaments Number DM & DL Total Allocated Total Cost
Product Ornaments per Box of Boxes per Box DM & DL Overhead Total Cost per Box
Small colored glass 420,000 12 35,000 4.00 $ 140,000 $ 599,268 $ 739,268 $ 21.12 $
Large colored glass 300,000 6 50,000 5.00 $ 250,000 428,049 678,049 13.56 $
Specialty ornaments 100,000 1 100,000 7.00 $ 700,000 142,683 842,683 8.43 $
820,000 185,000 1,090,000 $ 1,170,000 $ 2,260,000 $

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Exhibit 2

ZAUNER ORNAMENTS

Calculation of Product Costs: DM- and DL-Based Costing System



Number of Ornaments Number DM & DL Total Allocated Total Cost
Product Ornaments per Box of Boxes per Box DM & DL Overhead Total Cost per Box
Small colored glass 420,000 12 35,000 4.00 $ 140,000 $ 150,275 $ 290,275 $ 8.29 $
Large colored glass 300,000 6 50,000 5.00 $ 250,000 268,349 $ 518,349 10.37 $
Specialty ornaments 100,000 1 100,000 7.00 $ 700,000 751,376 $ 1,451,376 14.51 $
820,000 185,000 1,090,000 $ 1,170,000 $ 2,260,000 $

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Exhibit 3

ZAUNER ORNAMENTS

Activity Data by Product





Machine
Number of Number of Operations Ornaments Inspections Sq. Footage
Product Ornaments Batches per Ornament per Box per Box Per Box
Small colored glass 420,000 800 4 12 1 1
Large colored glass 300,000 750 4 6 2 0.5
Specialty ornaments 100,000 500 5 1 4 0.2

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Exhibit 4

ZAUNER ORNAMENTS

Historical Five-Year Plant-Administration Costs and Other Data





Total Plant
Administration Costs
Ending Inventory
Cost Plant Personnel
Number of
Customers
Total Direct
Labor Costs
% of Plant
Capacity Used
2003 $300,000 $90,000 122 1200 $520,000 70%
2002 295,000 83,000 122 1250 515,000 75%
2001 285,000 58,000 119 1100 555,000 85%
2000 280,000 50,000 112 800 540,000 90%
1999 290,000 76,000 116 600 500,000 95%


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Exhibit 5

ZAUNER ORNAMENTS

Plant Data by Product Line


Small Colored
Glass
Ornaments
Large Colored
Glass
Ornaments
Specialty
Ornaments Total
Ending inventory costs $26,100 $51,300 $12,600 $90,000
Plant personnel:
Non-specialty N/A N/A N/A 98
Specialty (painting) 24 24
Number of customers 600 420 180 1,200
Total direct labor costs $83,200 $93,600 $343,200 $520,000
% Plant capacity used N/A N/A N/A 70%