Reassess product costs using ABC (Learning Objective 2)

Owens, Inc., manufactures only two products, Medium (42-inch) and Large (63-inch) plasma screen TVs. To generate adequate profit and cover its expenses throughout the value chain, Owens prices its TVs at 300% of manufacturing cost. The company is concerned, because the Large model is facing severe pricing competition, whereas the Medium model is the low-price leader in the market. The CEO questions whether the cost numbers generated by the accounting system are correct. He’s just learned about ABC and wants to reanalyze this past year’s product costs using an ABC system. Information about the company’s products this past year is as follows:

Currently, the company applies manufacturing overhead on the basis of direct labor hours. The company incurred $800,000 of manufacturing overhead this year and 25,000 direct labor hours (9,000 direct labor hours making Medium TVs and 16,000 making Large TVs). The ABC team identified three primary production activities that generate manufacturing overhead costs:

The company’s only two products required the following activity levels during the year:

1. Use the company’s current costing system to find the total cost of producing all Medium (42-inch) TVs and the total cost of producing all Large (63-inch) TVs. What was the average cost of making each unit of each model? Round your answers to the nearest cent.
2. Use ABC to find the total cost of producing all Medium (42-inch) TVs and the total cost of producing all Large (63-inch) TVs. What was the average cost of making each unit of each model? Round your answers to the nearest cent.
3. How much cost distortion was occurring between Owens’ two products? Calculate the cost distortion in total and on a per unit basis. Could the cost dis¬ tortion explain the CEO’s puzzle about pricing competition? Explain.

Transcribed Image Text:

Medium (42-inch) Plasma TVs: Total direct material cost: $660,000 Total direct labor cost: $216,000 Production volume: 3,000 units Large (63-inch) Plasma TVs: Total direct material cost: $1,240,000 Total direct labor cost: $384,000 Production volume: 4,000 units