C8.40 Traditional versus simple activity-based product costing; strategic cost analysis: manufacturer LO 8.1 8.2 8.5 8.6 Gigabyte Ltd manufactures three products for the computer industry: gismos (product G): annual sales, 8000 units thingamajigs (product T): annual sales, 15000 units whatchamacallits (product W): annual sales, 4000 units. The company uses a traditional, volume-based product costing system with manufacturing overhead applied on the basis of direct labour dollars. The product costs have been calculated as follows: Raw material Product G $35.00 Product T $52.50 Product W $17.50 Direct labour Manufacturing overhead* Total product cost 16.00 (0.8 hr x $20) 140.00 ($16 x 875%) $191.00 12.00 (0.6 hr x $20) 105.00 ($12 x 875%) $169.50 8.00 (0.4 hr x $20) 70.00 ($8 x 875%) $95.50 Gigabyte's pricing method has been to set a budgeted selling price equal to 150 per cent of full product cost. However, only the thingamajigs have been selling at their budgeted price. The budgeted and actual current prices for all three products are the following:

Product cost Budgeted price Actual current selling price Product G $191.00 286.50 213.00 Product T $ 169.50 254.25 254.25 Product W $ 95.50 143.25 200.00 Gigabyte has been forced to lower the price of gismos in order to get orders. In contrast, Gigabyte has raised the price of whatchamacallits several times, but there has been no apparent loss of sales. Gigabyte has been under increasing pressure to reduce the price even further on gismos. In contrast, Gigabyte's competitors do not seem to be interested in the market for whatchamacallits. Gigabyte apparently has this market to itself. Required 1. Is product G the company's least profitable product? Explain your answer. 2. Is product W a profitable product for Gigabyte Ltd? Explain your answer. 3. Comment on the reactions of Gigabyte's competitors to the firm's pricing strategy. What dangers does Gigabyte face? 4. Gigabyte's financial controller, Nan O'Second, recently attended a conference at which activity- based costing systems were discussed. She became convinced that such a system would help Gigabyte's management understand its product costs better. She obtained top management's approval to design an activity-based costing system, and an ABC project team was formed. In stage 1 of the ABC project, each of the overhead items listed in the overhead budget was placed into its own activity cost pool. Then an activity driver was identified for each activity cost pool.

Finally, the ABC project team compiled data showing the percentage of each activity driver that was consumed by each of Gigabyte's product lines. These data are summarised as follows: Activity cost pool Activity driver Product G Product T Product W Machinery Machine hours 25% 50% 25% Machine setup Number of setups 20% 30% 50% Inspection Number of inspections 15% 45% 40% Material handling Raw material costs 25% 69% 6% Engineering Number of change orders 35% 10% 55% Show how the financial controller determined the percentages given above for raw material costs. (Round to the nearest whole per cent.) 5. Develop product costs for the three products on the basis of a simple activity-based product costing system. (Round to the nearest cent.) 6. Calculate a budgeted price for each product, using Gigabyte's pricing formula. Compare the new budgeted prices with the current actual selling prices and previously reported product costs. 7. Refer to the new budgeted prices for Gigabyte's three products, based on the new activity-based costing system. Write a memo to the company managing director commenting on the situation Gigabyte has been facing regarding the market for its products and the actions of its competitors. Discuss the strategic options available to management. What do you recommend, and why? 8. Refer to the product costs developed in requirement 5. Prepare a table showing how Gigabyte's traditional, volume-based product costing system distorts the product costs of gismos, thingamajigs and whatchamacallits.