C8.41 LO 8.1 8.2 8.5 8.6 Traditional versus simple activity-based costing, strategic cost analysis: manufacturer Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models called standard, deluxe and heavy-duty. The company uses a job costing system with manufacturing overhead applied on the basis of direct labour hours. The system has been in place with little change for 25 years. Product costs and annual sales data are as follows: Annual sales (units) Product costs: Standard model 20000 Deluxe model 1000 Heavy-duty model 10 000 Raw material $ 10 $ 25 $ 42 Direct labour 10 (0.5 hr @ $20) 20 (1 hr @ $20) 20 (1 hr @ $20) Manufacturing overhead* 85 170 170 Total product cost $ 105 $215 $232 For the past 10 years, the company's pricing formula has been to set each product's budgeted price at 110 per cent of its full product cost. Recently, however, the standard model motor has come under Increasing price pressure from offshore competitors. As a result the price on the standard model has been lowered to $110. The company CEO recently asked the financial controller, 'Why can't we compete with these other companies? They're selling motors just like our standard model for $106. That's only a dollar more than our production cost. Are we really that inefficient?"

The financial controller responded by saying, 'I think this is due to an outmoded product costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my opinion, our product costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean'. Getting the CEO's go-ahead, the financial controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each activity driver consumed by each product line. Product lines Activity Activity driver Standard model Deluxe model Heavy-duty model Depreciation, machinery Maintenance, machinery Machine time 40% 13% 47% Engineering Inspection and repair of defects Engineering hours 47% 696 47% Purchasing, receiving and shipping: Material handling Depreciation, taxes and Number of material orders 47% 8% 45% Insurance for factory Factory space usage 42% 15% 43% Miscellaneous manufacturing overhead Required 1. Calculate the budgeted prices for the three models, based on the traditional product costing system. 2. Calculate new product costs for the three products, based on the new data collected by the financial controller. Round to the nearest cent. 3. Calculate a new budgeted price for the three products, based on the activity-based costing system. Compare the new budgeted target price with the current actual selling price for the standard model electric motor. 4. Write a memo to the CEO explaining what has been happening as a result of using the firm's traditional product costing system. 5. What strategic options does Morelli Electric Motor Corporation have? What do you recommend and why? 6. Refer to the product costs developed in requirement 2 above. Prepare a table showing how Morelli's traditional product costing system distorts the product costs of the standard, deluxe and heavy-duty models.