Spokane Inc. produces three products- A-111, B-222, and C-333. While the products have been quite profitable over the past few years and the company operates at full capacity (based on machine hours), there has been increasingly competitive pressure recently which has caused the company to re-evaluate its products.

The company allocates manufacturing overhead on the basis of direct labour costs. The income statement for the most recent fiscal year is presented in Exhibit 1.

Based on these financial statements, the company is considering reducing production of the A-111 model, and transferring production to the C-333 model. They feel there is a chance to increase market share in that segment. From the profitability statement in Exhibit 1, they feel the C-333 model provides higher margins. The vice president of finance was not convinced this decision was appropriate. He decided to re-evaluate the allocation of overhead costs using activity based costing, before making a final decision on the A-111 model. The review was conducted with the understanding that there was no ability to increase available machine hours, from the current annual level of 28,250 hours, in the immediate future. All selling and administrative expenses are considered to be fixed.  

The vice-president reviewed the major components of overhead (a total of $1,200,000) and determined that the major activities driving the manufacturing overhead costs were:

1. Set-ups
2. Inventory handling
3. Machine operations

With the activities identified the vice-president determined the following unit rates for the activities, based on the information given in Exhibit 2:

Activity	Amount	Unit rate
Set-ups	$180,000	$300.00 per set-up hour
Inventory handling	210,000	$100.00 per material movement
Machine operations	810,000	$30.00 per machine hour

Exhibit 1

Spokane Inc.

Product Profitability Statement

	A-111	B-222	C-333	Total
Sales	$1,300,000	$1,100,000	$500,000	$2,900,000
Material costs	200,000	160,000	40,000	400,000
Direct labour	150,000	120,000	30,000	300,000
Overhead (@400%)	600,000	480,000	120,000	1,200,000
Cost of goods sold	950,000	760,000	190,000	1,900,000
Gross margin	$350,000	$340,000	$310,000	$1,000,000
Gross margin %	26.9%	30.9%	62.0%	34.5%
Volume	40,000	30,000	5,500
Potential Market Demand	45,000	34,000	10,000

Exhibit 2

Spokane Inc.

Production Information

		A-111	B-222	C-333
Sales volume		40,000	30,000	5,500
Production runs		50	30	25
Set-up time per run		2	5	14
Material movements per run		18	15	30
Machine hours per unit		.35	.25	1.0

Required:

1. Based on the above information, prepare a product profitability statement, using an ABC approach.

2. Compare the ABC results with the results provided by the “traditional” product profitability statement provided above. Do you agree with the company’s plan to reduce the production of the A-111 and increase the production of the C-333 model? What steps would you take to improve overall profitability?

3. The company has the opportunity to manufacture another product. The new product would sell for $29.00. Direct material cost is $6.50 and direct labor would be $4.00 per unit. Annual demand is expected to be 10,000 units. Production would take place in batches of 1,000 units and it would take .4 hours per unit of machine time. Set-up time would be three hours per batch. The number of material movements for this product would be 20 per set-up. Assume the unit rates you have developed in part 1 are valid for this product. Given this information, which products would you recommend Spokane produce?

Answer rating: 100% (QA)

Activitybased costing ABC may be a costing method that identifies activities in a corporation and assigns the value of every activity to all or any products and services consistent with the particular ... View the full answer