Refer to the text discussion of Lopez Plastics Company on pages 136–140. Assume that the company has the traditional cost accounting system described in Exhibit 4-6. The top management team wants to reverse the pattern of quarterly losses. The company president, Angie Oaks, has emphasized the importance of profit improvement by linking future pay raises of the two product-line managers to their respective gross profit margins. She is concerned about the profitability of the pen casing product line while pleased with the profitability of the cell phone casing line. She also believes that the unallocated costs of the company are too high compared to those of competitors. The office of controller, whose costs are included in the unallocated costs, is responsible for vendor relations and purchasing of direct materials. The controller presents the following idea:

We should use more standard parts in cell phone casings, which will dramatically reduce the purchasing department’s work required for purchasing. I believe this should cut our office’s costs by as much as $25,000 per quarter. In addition, using standard parts eliminates the need to purchase several expensive resins. The larger volume of purchases of less costly resin from fewer vendors will cut the cell phone casing direct-material cost by 10%. Product engineering agrees that this idea is not only feasible but, if implemented, would improve the overall quality of cell phone casings.

The controller and marketing manager provided the following summary of actions and related effects:

Action 

Reduce prices of cell phone casings 25%. 

Use standard parts wherever possible in cell phone casings. 

The vice president of sales estimates that the improved quality of cell phone casings combined with the price reduction will yield a 100% increase in demand for cell phone casings per quarter.

Expected effects

Total number of parts for each cell phone casing will not change, but the direct-material cost per casing will be reduced by 10% due to volume discounts from preferred vendors. The use of fewer suppliers will reduce vendor-relations work by the purchasing department.

This will result in unallocated costs decreasing by $25,000.

Processing time, measured in direct-labor hours, will increase by 500 hours due to expected 100% increase in sales and production of cell phone casings, but there is adequate capacity of labor and machine time. Direct-labor costs are fixed as are all of the indirect manufacturing costs.

Quality of cell phone casings will improve due to reduced complexity of processing.

1. Evaluate this idea using the traditional cost allocation system shown in Exhibit 4-6 on page 138.

What would be the predicted profitability for each product line and the company as a whole?

What would be the most likely level of support for the controller’s idea by the product managers of the pen casing product line and the cell phone casing product line? What would be the level of support by the president?

2. Assume that you have the ABC system described in Exhibit 4-7 on page 139 with the gross profit margins shown in the table in the solution to the first Summary Problem for Your Review on page 140 . Often, managers with ABC systems can anticipate more effects of improvement ideas because of their increased understanding of the operating system. In this case, although the total number of parts would not change, the idea would reduce the number of distinct parts for cell phone casings from 20 to 9. Evaluate the controller’s idea using the ABC system described in Exhibit 4-7. What would be the predicted profitability for each product line and the company as a whole? What would be the most likely level of support for the controller’s idea by the product managers of the pen casing product line and the cell phone casing product line? What would be the level of support by the president?

3. As vice president, you have expressed concern about the traditional cost-allocation system’s product-cost accuracy and its ability to provide relevant information for operational control. Does the new ABC system satisfy your concerns? Explain.