E4-33B Reassess product costs using ABC (Learning Objective 2)

James, Inc., manufactures only two products, Medium (42-inch) and Large (63-inch) TVs.

To generate adequate profit and cover its expenses throughout the value chain, James 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 lowprice leader in the market. The CEO questions whether the cost numbers generated by the accounting system are correct. The CEO 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:

Medium (42-inch) TVs:

Total direct material cost: $663,000 Total direct labor cost: $221,000 Production volume: 3,020 units Large (63-inch) TVs:

Total direct material cost: $1,320,000 Total direct labor cost: $390,000 Production volume: 4,180 units Currently, the company applies manufacturing overhead on the basis of direct labor hours. The company incurred $838,000 of manufacturing overhead this year, and 25,500 direct labor hours (9,500 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:

Materials Handling ($168,000); driven by number of material orders handled Machine Processing ($576,000); driven by machine hours Packaging ($94,000); driven by packaging hours The company’s only two products required the following activity levels during the year:

Material Orders Handled Machine Hours Packaging Hours Medium........................................................................... 360 20,200 4,120 Large............................................................................... 290 23,400 6,180 Requirements 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 the company’s two products?

Calculate the cost distortion in total and on a per unit basis. Could the cost distortion explain the CEO’s confusion about pricing competition? Explain.