1. Wow! is that Red-92 model ever a loser! It's time to cutback it's production shift our resources toward new Terry-95 model, Garry Taylor, executive vice-president of Taylor Products Inc. "Just look at the this income statement I've received from accounting. Terry-95 is generating over eight times as much as profit as Red-92 one-sixth of unit sales. I'm convinced that our future depend on the Terry-95. The year-end statement Thomas was referring is shown below.

	Total	Model
		Red-92	Terry-95
Sales	$ 11,125,000	$ 9,000,000	$ 2,125,000
Cost of Goods sold	$ 6,900,000	$ 5,490,000	$ 1,410,000
Gross Margin	$ 4,225,000	$ 3,510,000	$ 715,000
Less: Selling and Administrative Expense	$ 3,675,000	3,450,000	$ 225,000
Operating Income	$ 550,000	$ 60,000	$ 490,000
No. of units produced		$ 30,000	$ 5,000

"The numbers sure look that way", replied Judy Walker, the company's sales manager. "But why isn't competition more excited about T-95? I know we've been producing the model only for three years, but I am surprised that more of our competitors haven't recognized what a cash cow it is."

"I think it's our new automated plant", replied Taylor. "Now it takes only two direct labour-hours to produce a unit of the Red-92 and three direct labour-hours to produce a unit of the Terry-95. That's considerably less than it used to take us.

"I agree that automation is wonderful", replied Walker. "I suppose that's how we're able to hold down the price of T-95. Turner Company in England tried to bring out a Terry-95 but discovered they couldn't touch our price. But Turner is killing us on the Red-92 by undercutting our price with some of our best customers. I suppose they will pick all of our Red-92 business if we move out of that market. But who cares? We don't have to advertise T-95; it just seems to sell itself."

"My only concern about automation is how our manufacturing OH rate has shot up", replied Taylor. "But I think we've got a problem in production. Our total manufacturing OH cost is $2,700,000. That comes out to be a hefty amount per direct labour-hour, but Diana down in accounting has been using direct labour-hour as the base for computing overhead rates for years doesn't want to change. I don't suppose it matters as long as costs get assigned to the products".

"I've never understood that debit and credit stuff, replied Walker. "But I think we've got a problem in production. I had lunch with Jenny, our plant manager, yesterday and she complained about how complex T-95 to produce". Apparently, they have more work to with more machine setups, special soldering and also have to inspect each unit."

"It will have to wait", said Taylor. "I am writing a proposal to Board of Directors to phase out R-92. We've got to increase our bottom line or we'll all be looking for jobs".

Required:

1. Compute the predetermined overhead rate based on direct labour-hours that company used during the year.

2. Direct materials and labour costs per unit for the two products are below:

	Red-92	Terry-95
Direct Material	$ 75	$ 120
Direct labour	$ 36	$ 54

Using the data and rate computed in (1) above, determine the unit product cost of each product under the company's traditional costing system.

3. Assume company's $2,700,000 in manufacturing OH cost can be assigned to six activity cost pools as below:

		Expected Activity
Activity Cost Pool	Estimated OH Cost	Total	Red-92	Terry-95
Machine Setups (No.of setups)	$ 312,000	1,600	1,000	600
Quality Control (No. of inspections)	$ 540,000	9,000	4,000	5,000
Purchase Orders (No.of order)	$ 135,000	1,200	840	360
Soldering (No. of solder joints)	$ 675,000	200,000	60,000	140,000
Shipments (No. of Shipments)	$ 198,000	600	400	200
Machine Related (Machine -Hours)	$ 840,000	70,000	30,000	40,000
	$ 2,700,000

Given these data would you support a recommendation to expand sales of T-95? Explain your position.

4. From the data you prepared in (3) above, why do you suppose the T-95 "just seems to sell itself"

5. If you were the president of Thomas Products Inc. what strategy would you follow from this point forward to improve the company's overall profits?

2. Implementing an ABC system should proceed only if management believes the benefits of doing so will exceed the costs. The costs of an ABC system are not difficult to quantify. They include identifying the key activities, developing an information system to record and report information, collecting data for activity measures, and maintaining the system. More difficult to quantify are the benefits of adopting an ABC system.

Required:

Can you identify some qualitative benefits of adopting ABC? Can any of these be quantified? How could management deal with uncertainty related to any potential benefits of adopting an ABC system?