$1$ of $5$

UNIVERSITY

OVIRGINIA

DARDEN

UV$7382$

Business Publishing

Rev. Feb. $16,2018$

JW Sports Supplies $($B$)$

James Jones and William West were still working out together, still using exercise to help relieve the daily stress of the demanding careers they continued to pursue. Neither had icft his professional career to focus solely on JW Sports Supplies, which they had started together more than eight years ago, but the company continued to grow and operate at a profit. Exhibit $1$ presents the company's income statement for its most recent $($eighth$)$ year of operation.

At the beginning of its eighth year, the company had introduced a customizable gym bag. It had the same high quality of the company's basic model that had been so successful, but included the additional option for customers to add a customized logo$.$ The materials and labor costs were each $$5$ higher than for the basic model, but Jones and West thought the customized look added more than $$10$ in value to the bag. As a result, they had priced the custom gym bag at $$120,$$$20$ higher than the basic model. Throughout that year, the company sold an average of $2,000$ basic gym bags and $500$ custom gym bags per month, a sales level it expected for the upcoming year. Exhibit $2$ presents detailed data by product line.

The company used a simple, traditional overhead aliocation system to allocate both manufacturing and nonmanufacturing costs based on the number of units. In other words, each gym bag it made was allocated the same amount of overhead. "It's hard to belicve our new custom bag only costs $$10$ more to make than our bread$-$and$-$butter basic gym bag. Do you think that makes sense? I feel like every time I stop by the shop, there is so much effort being put into getting small orders of custom bags out the door. I$\text{'}$m wondering if it's worth it$."$ Jones asked West one evening during their friendly squash match. West replied, "I've been wondering that same thing. I took a managerial accounting course once, and we learned about something called activity$-$based costing. I don't remember much about it$,$ but it is supposed to help you estimate the costs that your products are causing you to incur, based on their use of the activities that are going on in the process. If a product takes a lot of your resources because you have to devote a lot of activities to it$,$ this system helps make sure that gets taken into account when you determine the cost of your products. Maybe this is something worth looking into."

After finishing their squash game, they agreed to spend the next few evenings after work looking into issues around overiead allocation. Rather than meeting at the gym for their regular workout, the next evening they met at West's apartment, ordered pizza, and started their analysis. They started by putting together a description of each of the company's cost categories $($Exhibit $3).$ They knew the amount of direct material, direct labor, and sales commission associated with basic gym bags and the amount associated with custom gym bags $($Exhibit $2).$ But they couldn't say the same thing about the remaining costs. Then they realized that those costs were the overhead costs that had to be allocated to determine the cost of each gym bag $($Exhibit $4$ presents montbly overhead costs by cost category$).$

This fictional case was prepared by Luann J$.$ Lynch$,$ Almand R$.$ Coleman Professor of Business Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright $($c$)2017$ by the University of Virginia Darden School Foundation, Charlottesville, VA$.$ All rights reserved. To order copies, send an e$-$mail to sales@dardenbusinesspublishing,com. No part of this pwblication may be noproduced, stored in a ntrieval system, used in a spreadsbeet, or transmitted in any form or by any means$-$electronic, medbanical, photocopying, mcording, or othenvisewithout the permission of the Darden Scbool Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to cditorial@dardenbusinesspublishing,com.

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At that point, their challenge became clear. They needed to consider how to allocate those costs so that they could get a good estimate of how much it cost to make a basic gym bag and how much it cost to make a custom gym bag. They decided to first allocate those costs using the traditional allocation system that they had been using. Then, they would spend some time using an activity$-$based costing approach to see if it led to different estimates of each gym bag's cost.

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Exhibit $1$

JW Sports Supplies $($B$)$

Income Statement for Most