ABC, implementation, ethics. (CMA, adapted) Applewood Electronics, a division of Elgin Corporation, manufactures two large-screen television models: the Monarch, which has been produced since 2006 and sells for $900, and the Regal, a newer model introduced in early 2009 that sells for $1,140. Based on the following income statement for the year ended November 30, 2010, senior management at Elgin have decided to concentrate Applewood's marketing resources on the Regal model and to begin to phase out the Monarch model because Regal generates a much bigger operating income per unit.
Applewood Electronics
Income Statement
For the Fiscal Year Ended November 30, 2010
Monarch Regal Total
Revenues $19,800,000 $4,560,000 $24,360,000
Cost of goods sold .12,540,000 .3,192,000 .15,732,000
Gross margin 7,260,000 1,368,000 8,628,000 Selling and administrative expense ..5,830,000 ...978,000 ..6,808,000
Operating income $.1,430,000 $..390,000 $.1,820,000
Units produced and sold 22,000 4,000
Operating income per unit sold $65.00 $97.50
Details for cost of goods sold for Monarch and Regal are as follows:
Monarch Regal Total Per unit Total Per unit
Direct materials $ 4,576,000 $208 $2,336,000 $584
Direct manufacturing labora 396,000 18 168,000 42
Machine costsb ..3,168,000 .144 ...288,000 ..72
Total direct costs $ 8,140,000 $370 $2,792,000 $698
Manufacturing overhead costsc $.4,400,000 $200 $..400,000 $100
Total cost of goods sold $12,540,000 $570 $3,192,000 $798 a
Monarch requires 1.5 hours per unit and Regal requires 3.5 hours per unit. The direct manufacturing labor cost is $12 per hour. b Machine costs include lease costs of the machine, repairs, and maintenance. Monarch requires 8 machine-hours per unit and
Regal requires 4 machine-hours per unit. The machine hour rate is $18 per hour. c
Manufacturing overhead costs are allocated to products based on machine-hours at the rate of $25 per hour.
Applewood's controller, Susan Benzo, is advocating the use of activitybased costing and activitybased management and has gathered the following information about the company's manufacturing overhead costs for the year ended November 30, 2010.
Total Activity Units of the Costallocation Base Activity Center (Costallocation Base) Costs Monarch Regal Total Soldering (number of solder points) $ 942,000 1,185,000 385,000 1,570,000 Shipments (number of shipments) 860,000 16,200 3,800 20,000
Quality control (number of inspections) 1,240,000 56,200 21,300 77,500
Purchase orders (number of orders) 950,400 80,100 109,980 190,080
Machine power (machine-hours) 57,600 176,000 16,000 192,000
Machine setups (number of setups) ...750,000 16,000 14,000 30,000
Total manufacturing overhead $4,800,000
After completing her analysis, Benzo shows the results to Fred Duval, the Applewood division president. Duval does not like what he sees. "If you show headquarters this analysis, they are going to ask us to phase out the Regal line, which we have just introduced. This whole costing stuff has been a major problem for us. First Monarch was not profitable and now Regal." "Looking at the ABC analysis, I see two problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. Second, you used number of setups and number of inspections as allocation bases. The numbers would be different had you used setup-hours and inspection-hours instead. I know that measurement problems precluded you from using these other costallocation bases, but I believe you ought to make some adjustments to our current numbers to compensate for these issues. I know you can do better. We can't afford to phase out either product."
Benzo knows that her numbers are fairly accurate. As a quick check, she calculates the profitability of Regal and Monarch using more and different allocation bases. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is con-fident that headquarters, knowing that Regal was introduced only recently, will not ask Applewood to phase it out. She is also aware that a sizable portion of Duval's bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Duval to do something.
1. Using activitybased costing, calculate the gross margin per unit of the Regal and Monarch models.
2. Explain briefly why these numbers differ from the gross margin per unit of the Regal and Monarch mod-els calculated using Applewood's existing simple costing system.
3. Comment on Duval's concerns about the accuracy and limitations of ABC.
4. How might Applewood find the ABC information helpful in managing its business?
5. What should Susan Benzo do in response to Duval's comments?