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West Chemical Company produces three products. The firm sets the target price of each
product at 150% of the product's total manufacturing cost. Recognizing that the firm was
able to sell Product C at a much higher price than the target price of the product and lost
money on Product B, To Watson, CEO, wants to promote Product C much more
aggressively and phase out Product B. He believes that the information suggests that
Product C has the greatest potential among the firm's three products since the actual
selling price of Product C was almost 50 percent higher than the target price while the
firm was forced to sell Product B at a price below the target price. Both the budgeted and
actual factory overhead for 2010 are $493,000. The actual units sold for each product also
are the same as the budgeted units. The firm uses direct labor dollars to estimate
manufacturing overhead costs. The direct materials and direct labor costs per unit for
each product are:
Target selling price (% of total mfg. cost) =
Budgeted factory overhead =
Actual factory overhead incurred =
150%
$493,000
$493,000
Actual Price
$280.00
$250.00
$300.00
Difference
$1.00
($44.00)
$100.50
The direct labor and direct materials cost per unit are as follows:
Direct Materials
Direct labor
Total prime cost
Product A
$50.00
$20.00
$70.00
Product B
$114.40
$12.00
$126.40
Product C
$65.00
$10.00
$75.00
The controller notes that not all of the products consume factory overhead costs similarly.
Upon further investigation, she identified the following overhead consumption data for
2007:
Number of setups
Weight of direct materials (pounds)
Waste and hazardous disposals
Quality inspections
Utilities (machine hours)
TOTAL
Product
A
2
400
25
30
2,000
Product
B
5
250
45
35
7,000
Product
C
3
350
30
35
1,000
Total
Overhead
$8,000
$100,000
$250,000
$75,000
$60,000
$493,000
Required
1. Determine the manufacturing cost per unit for each of the products using the
volume-based method.
2. What is the least profitable and the most profitable product under both the current
and the ABC costing systems?
3. What is the new target price for each product based on 150 percent of the new
costs under the ABC system? Compare this price with the actual selling price.
4. Comment on the result. As a manager of West Chemical, describe what actions
you would take based on the information provided by the activity-based unit
costs.
5-58
Superior Door Company (SDC) manufactures and sells two main product lines, exterior
doors and interior doors. Its products are sold through industry and wholesale suppliers.
SDC is known for their quality and value, and are often priced lower than competing
brands. During a recent executive meeting, Jerry Rhodes, the vice president of
marketing, made three observations: First, the price of the interior door (ID), a highvolume product for the firm, is often higher than that of competitors products. Second,
SDC has been struggling to maintain its market share of ID. Third, the firm has sold
approximately the same number of units of external doors (ED), a high margin product,
despite a 7.5 percent increase in price. Noting that the profit margin per unit of ED is
higher than that of ID, Rhodes has suggested that SDC should push for producing and
selling of ED. Regina Jones, the plant manager, objected to this strategy because the
manufacturing processes of ED were much more complicated than those for ID. The total
manufacturing costs would increase substantially if SDC shifted its product line to
emphasize ED.
Joseph Higgins, the vice president of finance, observes that SDC uses a direct labor costbased system to determine the amount of manufacturing overhead for all of its products.
Selected operating data for the year 2010 follow:
Product
ED
ID
Units Sold
5,000
50,000
Selling
Price per
Unit
$24
$150
$12
$80
Joseph also has collected the following data on activity cost pools and their cost
drivers:B101
Cost Pools/Activities
Machine operation
Support labor overhead
Machine setup
Assembly
Inspection
Cost Drivers
Machine-hours
Direct labor costs
Setup hours
Number of operators
Inspection hours
ID
7,500
$600,000
1,300
210,000
2,200
Chapter 5
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, 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%).
Product costs based on the activity-based costing system
Product A Product B
Product C
Direct materials
$ 50.00
$114.40
$ 65.00
Direct labor
20.00
12.00
10.00
Factory overhead:
Setups (a)
1.60
0.80
4.80
(b)
Materials handling
40.00
5.00
70.00
(c)
Hazardous control
62.50
22.50
150.00
(d)
Quality control
22.50
5.25
52.50
(e)
Utilities
12.00
8.40
12.00
Total Factory overhead
$138.60
$41.95
$289.30
Total Cost
$208.60
$168.35
$364.30
Actual selling price
Product manufacturing cost
Gross margin
Gross margin ratio
$280.00
208.60
$ 71.40
25.50%
$250.00
168.35
$ 81.65
32.66%
$300.00
364.30
($64.30)
(21.43)%
Chapter 5
Chapter 5
5-54 (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
$280.00
$32.90
$ 94
33.57%
$ 54
21.6%
$167
55.67%
$71.40
25.50%
$81.65
32.66%
$(64.30)
(21.43%)
$252.53
$250.00
$ 2.52
$546.45
$300.00
$246.45
Chapter 5
Units
Sold
5,000
50,000
Materials
$40
$30
Labor
$24
$12
$200,000
$150,800
$82,500
$140,875
$66,250
$640,425
Selling Price
$150
$80
Total Activity Exterior Door Interior Door
10,000
2,500
7,500
$ 720,000 $
120,000 $ 600,000
2,500
1,200
1,300
402,500
192,500
210,000
4,000
1,800
2,200
0.889 =$640,425/$720,000
Total
Per Unit
$ 106,738 $
21.35
533,688
10.67
Exterior Door
Activities
Overhead
2,500
$50,000
120,000
$25,133
1,200
$39,600
192,500
$67,375
1,800
$29,813
$211,921
Interior Door
Activities
Overhead
7,500
$150,000
600,000
$125,667
1,300
$42,900
210,000
$73,500
2,200
$36,438
$428,504
Chapter 5
5-58 (continued-1)
Total
Number of units
Sales
Direct materials
Direct Labor
Overhead
Machine Operation
Support Labor
Machine Setup
Assembly
Inspection
Total Overhead
Total Manufacturing Costs
Gross Margin
Gross Margin Percent
Exterior Door
Interior Door
Per Unit
Total
Per Unit
5,000
50,000
750,000 $
150.00
4,000,000 $
80.00
200,000
40.00
1,500,000
30.00
120,000
24.00
600,000
12.00
50,000.00
25,133.33
39,600.00
67,375.00
29,812.50
211,920.83
531,920.83
$ 218,079.17 $
29.08%
42.38
150,000.00
125,666.67
42,900.00
73,500.00
36,437.50
428,504.17
106.38
43.62
2,528,504.17
$ 1,471,495.83
8.57
50.57
29.43
36.79%
3. The above profitability analysis indicates that the Exterior Door is not as
profitable as the vice president of marketing thinks it is.
Chapter 5
5-58 (continued-2)
4. Unit Cost Comparison of overhead costs between the current and
ABC costing systems
Cost Comparison of Overhead costs per unit
Volume-based
Activity Based
Difference (ABC-VB)
$
$
Ext. Doors
21.35
42.38
21.04
Int. Doors
10.67
8.57
$
(2.10)