Reliable Machining Products (RMP) is an automotive component supplier. RMP has been approached by Chrysler with a proposal to significantly increase production of Part T151A to a total annual quantity of 100,000. Chrysler believes that by increasing the volume of production of Part T151A, RMP should realize the benefits of economies of scale and hence should accept a lower price than the current $6 per unit. Currently, RMP’s gross margin on Part T151A is 3.3 percent, computed as follows: 

The 400 percent overhead allocation rate is based on $3,300,000 annual factory overhead divided by $825,000 annual direct labour.

                                                                                                                    Total Per Unit (÷100,000)
Direct materials .............................................................................................$150,000 $ 1.50
Direct labour .........................................................................................................86,000 0.86
Factory overhead [400% × direct labour] .......................................................344,000 3.44
Total cost ........................................................................................................$580,000 $5.80
Sales price .........................................................................................................................6.00
Gross margin ..................................................................................................................$0.20
Gross margin percentage ...............................................................................................3.3%

Activity Centre: Cost Drivers                                                                     Annual Cost Driver Quantity
Quality: No. of pieces scrapped .............................................................................10,000
Production Scheduling and Setup: No. of setups .....................................................500
Shipping: No. of containers shipped .....................................................................60,000
Shipping Administration: No. of shipments ...........................................................1,000
Production: No. of machine-hours .........................................................................10,000

Part T151A seems to be a marginal profit product. If additional volume of production of Part T151A is to be added, RMP management believes that the sales price must be increased, not reduced as requested by Chrysler. The management of RMP sees this quoting situation as an excellent opportunity to examine the effectiveness of their traditional costing system versus an activity-based costing system. Data have been collected by a team consisting of accounting and engineering analysts.

Activity Centre                                                             Traceable Factor Overhead Costs (Annual)
Quality ...............................................................................................$ 800,000
Production scheduling .........................................................................50,000
Setup ....................................................................................................600,000
Shipping ...............................................................................................300,000
Shipping administration ......................................................................50,000
Production .......................................................................................1,500,000
Total costs ......................................................................................$3,300,000

The accounting and engineering team has provided the following costdriver consumption estimates for the production of 100,000 units of Part T151A:

Cost Driver                             Cost-Driver Consumption
Pieces scrapped ..............................1,000
Setups ...................................................12
Containers shipped ...........................500
Shipments ..........................................100
Machine-hours ...................................500

1. Prepare a schedule calculating the unit cost and gross margin of Part T151A using the activity-based costing approach.

2. Based on the ABC results, what course of action would you recommend regarding the proposal by Chrysler? List the benefits and costs associated with implementing an activity-based costing system at RMP.