Activity Based Costing Case

"I say it's time we cut back on the X-20 model and shift our resources toward the new Z-50 model," said Britta Warnick, executive vice president of Abdex Products, Inc. "Just look at this statement I've received from accounting. The Z-50 is generating more than sixteen times the profits of the X-20, and it has only about one fifth as much in sales. I've become convinced that our future depends on the Z-50." The statement to which Britta was referring follows:

ABDEX PRODUCTS, INC.

Income Statement

For the Year Ended January 31, 2021

Total Z-50 X-20

Sales $ 2,330,000 $ 430,000 $1,900,000

Cost of goods sold 1,920,000 220,000 1,700,000

Gross margin 410,000 210,000 200,000

Less selling and

administrative expenses 233,000 43,000 190,000

Net Income $177,000 $ 167,000 $ 10,000

Number of units

produced and sold - 1,000 5,000

Net income per unit sold - $167 $2

"The numbers sure look that way," replied Jahi Zayas, the company's sales vice president. "But why aren't our competitors more excited about the Z-50? I know we've only been producing the product for three years, but it seems like more of them would recognize what a money maker it is."

"I think its our new automated plant," said Britta. "Now it takes only two direct labor-hours to produce a unit of the Z-50 and three hours to produce a unit of the X-20. That's half of what it used to take us."

"Automation is marvelous," replied Jahi. "I suppose that's how we're able to hold down the price on the Z-50. Why, Ajama Company in Japan started to bring out a Z-50 but discovered they couldn't touch our price. But Ajama is killing us on the X-20; I suppose they'll pick up our X-20 customers as we move out of that market. But who cares? We don't even have to advertise the Z-50; it just seems to sell itself."

"My only concern about automation is how our overhead rate has shot up," said Britta. "Our total overhead cost was $816,000 for 2021. That comes out to a hefty amount per direct labor-hour, but old David down in accounting has been using labor-hours as a base for computing overhead rates for years and doesn't want to change. I don't suppose it matters so long as costs get assigned to products."

"That bookkeeping bores me," replied Jahi. "But I think you've got a problem in production. I had lunch with Zaha yesterday, and she was complaining about how complex the Z-50 is to produce. Apparently, they have to do a lot of machine setups and other engineering work just to keep production moving on the Z-50. "

"It'll have to wait," said Britta. "I'm writing a proposal to the board to phase out the X-20 as rapidly as possible. We've got to bring those profits up or we'll all be looking for jobs."

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Assume that there was no under or overallocated overhead for the year and that direct materials and direct labor (per unit of output) for the products were as follows:

Z-50 X-20

Direct Materials $100 $160

Direct Labor $ 24 $ 36

Assume also that the company's $816,000 in overhead cost is related to four activities as follows:

		Number of Events or Transactions
	Activity Cost	Total	Z-50	X-20
Machine Related Costs	$450,000	9,000 machine-hrs	4,000 machine-hrs	5,000 machine-hrs
Setup and Inspections	180,000	40 production runs	20 production runs	20 production runs
Engineering Change	90,000	100 change orders	75 change orders	25 change orders
Plant Related Costs	96,000	1,920 sq. ft.	1,536 sq. ft.	384 sq. ft.
	$816,000

Taking the role of the Assistant Controller (and assuming you would like to keep your job), prepare the memo Brittai Warnick requested. Assume that because of your excellent training in cost accounting from the University of Maryland, some of the things you heard at the meeting troubled you and after the meeting, you did some additional analysis on your own comparing an ABC system and a traditional system for Abdex. Based on your analysis, you decided to present your findings in a memo to Warnick.

In your memorandum, you should put forth specific recommendations. The memorandum should be viewed as a document of persuasion. (Be careful to consider your primary and secondary audience and your position within the firm.) Your report should be limited to one page (typed and single spaced), but may be supplemented by diagrams, tables, and other exhibits to provide support for the recommendations and arguments put forth.