Product profitability analysis Petersen Pneumatic Company makes three products. Its manufacturing plant in Petersburg has three production depart¬ ments and three service departments.

The profitability of the Petersburg plant has been declining for the past three years despite the successful introduction of the new product, GT103, which has now captured more than a 60% share of its segment of the indus¬ try. In an attempt to understand the reasons for its declining profitability, the company has appointed a special task force.
The task force is considering a new cost accounting system based on ac¬ tivity analysis. This system employs five cost drivers: three departmental DLH, setups (SET), and orders (ORD). Each departmental cost pool is divided into homogeneous cost pools identified with a unique driver. The following table presents the percent of the departmental support costs that are put in each of the homogeneous cost pools. The total amounts in the five cost pools are allo¬ cated to the three products based on their respective cost drivers.

Peter Gamble is the leader of the task force responsible for activity-based cost analysis. He interviewed Nola Morris, who was responsible for the setup and scheduling department, to determine the cost drivers for the departmental support costs.

Gamble: How many people work in the setup and scheduling department?
Morris: I have 12 people who work on setups. Three more are responsible for production scheduling. I spend most of my time supervising them.
Gamble: How do you assign setup workers to production jobs?
Morris: Almost all the time they set up machines in the machining depart¬ ment. The effort depends only on the number of setups.
Gamble: On what does the time spent on scheduling depend?
Morris: It depends on the number of orders.
Gamble: So a large batch or order will require the same amount of setup and scheduling time as a small batch or order.
Morris: Yes, that's right.
REQUIRED

(a) List the reasons that the old cost accounting system at Petersen Pneumatic may be distorting its product costs.

(b) Determine the product cost per unit using both the old and new cost ac¬ counting systems. Show all the intermediate steps including the cost dri¬ ver rates, amounts in the three new cost pools, and a breakdown of product costs into each of their components.

(c) Analyze the profitability of the three products. What insight is provided by the new profitability analysis? What should Petersen Pneumatic do to improve the profitability of its Petersburg plant?

(d) Mike Meservy is a veteran production manager and Shannon Corinth is a marketing manager with considerable experience as a salesperson. Dis¬ cuss how each of them is likely to react to your analysis and recommen¬ dations. Explain how their expected reactions may affect the way you will present your recommendations.

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DEPARTMENT Machining (MC) Plating (PL) Assembly (AS) Purchasing and inventory (PI) Setup and scheduling (SS) Quality control (QC) SUPPORT COSTS $ 40,000 50,000 15,000 50,000 120,000 70,000