Lenngton Furniture, Inc. (LFI) manufactures bedroom furniture in sets (a set includes a dresser, two queen-size beds, and one bedside table) for use in motels and hotels. LFI has three customer groups, which it calls the value, quality, and luxury groups. The value products are targeted to low-price motels that are looking for simple furniture, while the luxury furniture is targeted to the very best hotels. The value line is attractive to a variety of hotels and motels that appreciate the combination of quality and value. Currently there has been a small increase in the low-cost and value lines, and an appreciable increase in demand in the luxury line, reflecting cyclical changes in the marketplace. Luxury hotels are now in more demand for business travel, while a few years ago, the value segment was the most popular for business travelers. LFI wants to be able to respond to the increased demand with increased production but worries about the increased production cost and about price setting as its mix of customers and production change. LFI has used a volumebased rate based on direct labor-hours for some time. Direct labor cost is $12 per hour.

 

	Budgeted Cost		Cost Driver
Materials handling	$349,600		Number of Parts
Product Scheduling	$160,000		Number of Production orders
Setup Labor	$216,000		Number of setups
Automated Machinery	$1,750,000		Machine hours
Finishing	$619,500		Direct labor hours
Pack and Ship	$290,400		Number of orders shipped
	$3,385,500
General, Selling, and Adm Costs	$5,000,000

The budgeted production data for the three product lines follows.

 

Product Lines	Value	Quality	Luxury
Units Produced	15,000	5,000	500
Price	$300	$400	$500
Direct Materials cost per unit	$80	$50	$110
Number of Parts per unit	30	50	120
Direct Labor Hours per unit	4	5	7
Machine Hours per unit	3	7	15
Production Orders	50	70	200
Production Setups	20	50	50
Orders Shipped	1,000	2,000	300
Number of Inspections	2	6	14

 

Cost Driver		Practical Capacity
Number of Parts		990,000
Number of Production orders		800
Number of setups		200
Machine hours		100,000
Direct labor hours		123,900
Number of orders shipped		5,000

Required

1. Determine the cost per set and the total production cost of each of the three customer groups using activity-based costing.

2. Determine the production cost for each of the three customer groups using LFI’s current volume-based approach.

3. The activity usage data given in the problem reflects current usage of the various cost drivers to manufacture the firm’s product lines. Suppose you are given the following information regarding the firm’s practical capacity for each of these activities, as follows:

Cost Driver Practical Capacity

Number of parts ........990,000

Number of production orders ... 800

Number of setups ......... 200

Machine-hours .......... 100,000

Direct labor-hours ........123,900

Number of orders shipped ..... 5,000

Comment on how you would use this additional information for costing the firm’s products and assisting in strategic planning.

4. Compare the two approaches and discuss the strategic and competitive issues of using each of the twomethods.