Jones, Inc., manufactures only two products, Medium (42-inch) and Large (63-inch) plasma screen TVs. To generate adequate profit and cover its expenses throughout the value chain, Jones prices its TVs at 300% of manufacturing cost. The company is concerned because the Large model is facing severe pricing competition, whereas the Medium model is the low-price leader in the market. The CEO questions whether the cost numbers generated by the accounting system are correct. He has just learned about ABC and wants to reanalyze this past year's product costs using an ABC system.
Information about the company's products this past year is as follows:
Medium (42-inch) Plasma TVs
Total direct material cost: $660,000
Total direct labor cost: $225,000
Production volume: 3,200 units
Large (63-inch) Plasma TVs:
Total direct material cost: $1,227,000
Total direct labor cost: $388,000
Production volume: 4,000 units
Currently, the company applies manufacturing overhead on the basis of direct labor hours. The company incurred $820,000 of manufacturing overhead this year and 20,500 direct labor hours (7,875 direct labor hours making Medium TVs and 12,625 making Large TVs). The ABC team identified three primary production activities that generate manufacturing overhead costs:
Materials Handling ($120,000); driven by number of material orders handled
Machine Processing ($600,000); driven by machine hours
Packaging ($100,000); driven by packaging hours
Material Orders Machine Packaging
Handled Hours Hours
Medium . . . . . . . . . . . . . . . . . . . . . . 350. . . . . . . . . 25,000. . . . . . . . . 3,000
Large . . . . . . . . . . . . . . . . . . . . . . . . 250. . . . . . . . . 15,000. . . . . . . . . 7,000
Requirements
1. Use the company's current costing system to fi nd the total cost of producing all Medium (42-inch) TVs and the total cost of producing all Large (63-inch) TVs. What was the average cost of making each unit of each model? Round your answers to the nearest cent.
2. Use ABC to find the total cost of producing all Medium (42-inch) TVs and the total cost of producing all Large (63-inch) TVs. What was the average cost of making each unit of each model? Round your answers to the nearest cent.
3. How much cost distortion was occurring between Jones' two products? Calculate the cost distortion in total and on a per unit basis. Could the cost distortion explain the CEO's confusion about pricing competition? Explain.