CASE 6-2 QUANTUMTM [LO 2] QuantumTM manufactures electronic testing and mea- device and an order for 1 harmonic analyzer. The costs and prices surement instruments. Many products are custom-designed charged were as follows: with recent orders for function generators, harmonic analyzers, Temperature logic analyzers, temperature measurement instruments, and Harmonic Monitor data-logging instruments. The company prices its instruments Analyzer at 30 percent over estimated cost (excluding administrative and Component cost per unit $ 250 $2,500 selling costs). 25 Recently, senior management has noted that its product mix Direct labor per unit 500 2,500 has changed. Specifically, the company is receiving fewer large Overhead per unit 120 orders for instruments that are relatively simple to produce, and Cost per unit 395 5,500 119 customers are saying that the company is not price competi- Markup at 30% 1,650 tive. The company is, however, receiving more small orders for Price per unit $ 514 $7,150 complex instruments, and customers appear quite happy to pay Number of units 900 QuantumTM's price. This situation was discussed at a weekly Value of order $462,600 $7,150 management meeting. Jason Norton, VP of operations, blamed the company's antiquated cost accounting system. "Look," he said, "if you have bad cost information, you're going to have bad prices, In the current system, overhead is applied based on an estimate of and we're still doing product costing the way companies did it in $50,000,000 of annual overhead and $10,000,000 of direct labor the 1930s. I've been reading articles about activity-based costing, cost. The consultants have broken the $50,000,000 of annual over- and they indicate that out-of-date costing systems make simple head down into six cost pools and identified related cost drivers products look too costly and complex products too cheap. If that's as indicated in Exhibit 1. The consultants have also found that the true, it would explain why we're not price competitive for simple monitor and analyzer make use of the cost drivers as indicated in Exhibit 2. products." The meeting ended with a decision to hire a consultant to con- duct a preliminary ABC study to determine how a switch to ABC REQUIRED would affect product cost. The consulting firm selected two recent a. Based on the consultants' work to date, calculate the ABC cost orders for study: a 900-unit order for a temperature-monitoring per unit of each product.The consultants have completed their job, and QuantumI'M has adopted an ABC system as indicated in Exhibit 1. Recently, the company received an order for a unique data-logging device. c. Suppose QuantumTM meets its competitor's price and gets The device will require $9,000 of components and $3,000 of the job. What will be the impact on company profit? In answer- direct labor along with the following requirements: ing this question, make the following assumptions: 1. 40 percent of design costs are fixed, and 60 percent vary with design hours. Use related to a data logging device: 2. 30 percent of material ordering and handling costs are Number of design hours fixed, and 70 percent vary with the number of unique parts. Number of unique parts 27 17 3. 50 percent of inspection costs are fixed, and 50 percent Number of inspections are variable. Number of setups 12 4. 80 percent of setup costs are fixed, and 20 percent are Machine hours variable. 10 5. 20 percent of labor-related costs are fixed, and 80 percent The customer has indicated that it currently has a low bid are variable. from another company of $22,000. Calculate the ABC cost of the 6. Prices charged to this customer or other customers in the data-logging device. future will not be impacted by the current deal. This fol- lows because each order is unique. EXHIBIT 1 Cost Pools Annual Cost Annual Driver Value Cost pools and drivers Product design $ 8,000,000 160,000 design hours Material ordering and handling 10,000,000 125,000 unique part's Inspection 3,500,000 560,000 inspections Setup 2,500,000 80,000 setups Labor-related overhead 8,000,000 $10,000,000 direct labor Depreciation of plant and equipment 18,000,000 225,000 machine hours $50,000,000 EXHIBIT 2 The following values relate to the entire order The following values relate to the order for Use of cost driver of 900 monitors (this is not per monitor): 1 analyzer: Number of design hours 47 Number of design hours 110 Number of unique parts 17 Number of unique parts 25 Number of inspections 225 Number of inspections 20 Number of setups Number of setups Machine hours 112 Machine hours 7