Refer to the Lopez Plastics illustration, starting with the financial reports based on the traditional cost accounting system in panel B of Exhibit 4.6, p. 131. Based on these reports, a marketing manager has proposed a plan that emphasizes mobile phone casings due to their large gross profit margin (38.75 per cent) compared to that of pen casings (1.25 per cent).

Exhibit 4.6

Now, management implements the ABC system shown in Exhibit 4.7, p. 133. The first stage of the two-stage ABC system has been completed and the results are the activity-cost-pool figures given in Exhibit 4.7 – processing activity costs of €143,000 and production-support activity costs of €77,000. You need to perform the second-stage allocations to determine the profitability of each product line. The cost-allocation base for processing activity is directlabour hours and the cost-allocation base for production-support activity is number of distinct parts. Data on the use of these cost-allocation bases for the last quarter are as follows:

Exhibit 4.7

Calculate the gross profit and gross profit margin for each product based on ABC. Do your results differ significantly from those based on the traditional cost accounting system in Exhibit 4.6? Explain. Evaluate marketing’s plan. Propose a product-mix strategy for the company.

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Panel A Process map of Lopez Plastics Company's traditional cost system Direct materials for pen casings €22,500 All indirect production costs € 220,000 Cost allocation base [direct labour hours] Direct labour for pen casings €135,000 Direct materials for mobile phone casings €12,000 SALES €360,000 *€ 220,000 x (4,500 + 5,000) = €198,000 +€220,000x (500 ÷ 5,000) = €22,000 SALES €80,000 All unallocated value chain costs €100,000 Direct labour for mobile phone casings €15,000 UNALLOCATED €100,000 Panel B Lopez Plastics Company statement of operating income traditional cost allocation system Statement of operating income [external reporting purpose Sales Cost of goods sold: Direct material Direct labour Indirect production Cost of goods sold Gross profit Corporate expenses (unallocated) Operating loss Gross profit margin Pen Mobile phone casings casings €440,000 €360,000 €80,000 34,500 22,500 12,000 150,000 135,000 15,000 Contribution to corporate costs and profit [internal strategic decision-making purpose] 220,000 198,000* 22,000+ 404,500 355,500 49,000 35,500 100,000 (€64,500) 8.07% €4,500 €31,000 1.25% 38.75%