5 Howard Rockness was worried. His company, Rockness Bottling, showed declining profits over the past several years despite an increase in revenues. With profits declining and revenues increasing, Rockness knew there must be a problem with costs. Rockness sent an e-mail to his executive team under the subject heading, "How do we get Rockness Bottling back on track?" Meeting in Rockness's spacious office, the team began brainstorming solutions to the declining profits problem. Some members of the team wanted to add products. (These were marketing people.) Some wanted to fire the least efficient workers. (These were finance people.) Some wanted to empower the workers. (These people worked in the human resources department.) And some people wanted to install a new computer system. (It should be obvious who these people were.) Rockness listened patiently. When all participants had made their cases, Rockness said, "We made money when we were a smaller, simpler company. We have grown, added new product lines, and added new products to old product lines. Now we are going downhill. What's wrong with this picture?" Rockness continued, "Here, look at this report. This is last month's report on the cola bottling line. What do you see here?" He handed copies of the following report to the people assembled in his office. Monthly Report on Cola Bottling Line Sales Less: Materials Direct labor Fringe benefits on direct labor Indirect costs (@260% of direct labor) Gross margin Return on sales (see note [a]) Volume Unit price Unit cost Diet $170,000 Regular $108,000 Cherry $32,800 Grape $9,675 Total $320,475 71,000 20,500 51,200 11,500 16,320 3,200 6,125 550 144,645 35,750 8,200 4,600 1,280 220 14,300 53,300 29,900 8,320 1,430 92,950 $ 17,000 10.0% 85,000 $ 10,800 10.0% $ 3,680 $1,350 $ 32,830 54,000 $ $ 2.00 1.80 $ 2.00 11.2% 16,000 2.05 14.0% 4,500 $ 2.15 $ 10.2% 159,500 2.01 $ 1.80 $ 1.82 $ 1.85 $ 1.80 a Return on sales before considering selling, general and administrative expenses. Rockness asked, "Do you see any problems here? Should we drop any of these products? Should we reprice any of these products?" The room was silent for a moment, and then everybody started talking at once. Nobody could see any problems based on the data in the report, but they all made suggestions to Rockness ranging from "add another cola product" to "cut costs across the board" to "we need a new computer system so that managers can get this information more quickly." A not-so-patient Rockness stopped the discussion abruptly and adjourned the meeting. He then turned to the quietest person in the room-his son, Rocky-and said, "I am suspicious of these cost data, Rocky. Here we are assigning indirect costs to these products using a 260 percent rate. I really wonder whether that rate is accurate for all products. I want you to dig into the indirect cost data, figure out what drives those costs, and see whether you can give me more accurate cost numbers for these products." Rocky first learned from production that the process required four activities: (1) setting up production runs, (2) managing production runs, and (3) managing products. The fourth activity did not require labor; it was simply the operation of machinery. Next, he went to Indirect labor Fringe benefits on indirect labor Information technology Machinery depreciation Machinery maintenance Energy Total $ 35,750 14,300 23,300 11,500 5,400 2,700 $ 92,950 Then, he began a series of interviews with department heads to see how to assign these costs to cost pools. He found that 40 percent of indirect labor was for scheduling or for handling production runs, including purchasing, preparing the production run, releasing materials for the production run, and performing a first-time inspection of the run. Another 50 percent of indirect labor was used to set up machinery to produce a particular product. The remaining 10 percent of indirect labor was spent maintaining records for each of the four products, monitoring the supply of raw materials required for each product, and improving the production processes for each product. This 10 percent of indirect labor was assigned to the cost driver "number of products." Interviews with people in the information technology department indicated that $23,300 was allocated to the cola bottling line. 80 percent of this $23,300 information technology cost was for scheduling production runs. 20 percent of the cost was for record keeping for each of the four products. Fringe benefits were 40 percent of labor costs. The rest of the overhead was used to supply machine capacity of 31,900 hours of productive time. Rocky then found the following cost driver volumes from interviews with production personnel. Setups: 770 labor-hours for setups. Production runs: 285 production runs. Number of products: 4 products. Machine-hour capacity: 31,900 hours. Diet cola used 270 setup hours, 110 production runs, and 8,500 machine-hours to produce 85,000 units. Regular cola used 95 setup hours, 65 production runs, and 5,400 machine-hours to produce 54,000 units. Cherry cola used 310 setup hours, 65 production runs, and 1,600 machine-hours to produce 16,000 units. Grape cola used 95 setup hours, 45 production runs, and 450 machine-hours to produce 4,500 units. Rocky learned that the production people had a difficult time getting the taste just right for the Cherry and Grape colas, so these products required more time per setup than either the Diet or Regular colas. Required: a. Recompute the unit costs for each of the cola products: Diet, Regular, Cherry, and Grape. b. What is the cost of unused capacity? c. Now assume that Rockness is considering producing a fifth product: Vanilla cola. Because Vanilla cola is in high demand in Rockness Bottling's market, assume that it would use 15,950 hours of machine time to make 159,500 units. (Recall that the machine capacity in this case is 31,900 hours, while Diet, Regular, Cherry, and Grape consume only 15,950 hours.) Vanilla cola's per unit costs would be identical to those of Diet cola except for the machine usage costs. What would be the cost of Vanilla cola? Calculate on a Required A Required B Required C Recompute the unit costs for each of the cola products: Diet, Regular, Cherry, and Grape. (Round cost driver rates to 3 decimal places and other intermediate calculations to nearest whole dollar value. Round cost per unit answers to 2 decimal places.) Materials Direct labor Fringe benefits on direct labor Setup costs Production run costs Product costs Machine costs Total costs Volume Cost per unit Unit Costs on Cola Bottling Line Diet Regular Cherry Grape Total 0 0 0 0 0 0 0 0 0 $ $ 0 Required A Required B Required C What is the cost of unused capacity? Cost of the unused capacity Required A Required B Required C Now assume that Rockness is considering producing a fifth product: Vanilla cola. Because Vanilla cola is in high demand in Rockness Bottling's market, assume that it would use 15,950 hours of machine time to make 159,500 units. (Recall that the machine capacity in this case is 31,900 hours, while Diet, Regular, Cherry, and Grape consume only 15,950 hours.) Vanilla cola's per unit costs would be identical to those of Diet cola except for the machine usage costs. What would be the cost of Vanilla cola? Calculate on a per-unit basis, and then in total. (Do not round intermediate calculations. Round "Per unit" to 5 decimal places.) Show less Cost of vanilla cola per unit Total cost of vanilla cola produced 4 WSM Corporation is considering offering an air shuttle service between Sao Paulo and Rio de Janeiro. It plans to offer four flights every day (excluding certain holidays) for a total of 1,400 flights per year (= 350 days x 4 flights per day). WSM has hired a consultant to determine activity-based costs for this operation. The consultant's report shows the following. Activity Activity Measure (cost Unit Cost (cost per unit of driver) Flying and maintaining aircraft Number of flights Serving passengers Number of passengers Advertising and marketing Number of promotions activity) $ 1,400 per flight $ 5 per passenger $49,000 per promotion WSM estimates the following annual information. With 14 advertising promotions, it will be able to generate demand for 40 passengers per flight at a fare of $195. The lease of the 60-seat aircraft will cost $3,800,000. Other equipment costs will be $1,900,000. Administrative and other marketing costs will be $1,050,000. Required: a. What annual operating income can WSM expect from this new service? b-1. WSM is considering selling tickets over the Internet to save on commissions and other costs. It is estimated that the cost driver rate for flights would decrease by $100 as a result of Internet sales. Administrative and other marketing costs would increase by $1 million. WSM estimates that the added convenience would generate a 5 percent increase in demand. All other costs and fares would remain the same. What annual operating income can WSM expect from adopting Internet ticket sales? b-2. Would you recommend that WSM adopt Internet ticket sales? c. Assume that WSM management decides not to adopt the Internet strategy, regardless of your answer to requirement (b). Instead, it is now considering a plan to sell tickets at two prices. An unrestricted ticket (good for travel at any time on any day) would sell for $ 220. A discount ticket, good for reservations made in advance, would sell for $155. Management estimates that it can sell 35,000 tickets (25 per flight) at the unrestricted airfare of $220. All other data remain the same. Ignoring the information in requirement (b), how many discounted tickets would WSM have to sell annually to earn an operating income of $1,300,000? Assume that the annual number of flights remains at 1,400 and that the discounted tickets would be evenly divided across the 1,400 flights. Complete this question by entering your answers in the tabs below. Req A Req B1 Req B2 Req C What annual operating income can WSM expect from this new service? (Enter your answer in thousands of dollars.) Operating income Req A Req B1 Req B2 Req C WSM is considering selling tickets over the Internet to save on commissions and other costs. It is estimated that the cost driver rate for flights would decrease by $100 as a result of Internet sales. Administrative and other marketing costs would increase by $1 million. WSM estimates that the added convenience would generate a 5 percent increase in demand. All other costs and fares would remain the same. What annual operating income can WSM expect from adopting Internet ticket sales? (Enter your answer in thousands of dollars.) Show less Operating income Req A Req B1 Req B2 Req C Would you recommend that WSM adopt Internet ticket sales? O Yes ONo Req A Req B1 Req B2 Req C Assume that WSM management decides not to adopt the Internet strategy, regardless of your answer to requirement (b). Instead, it is now considering a plan to sell tickets at two prices. An unrestricted ticket (good for travel at any time on any day) would sell for $ 220. A discount ticket, good for reservations made in advance, would sell for $155. Management estimates that it can sell 35,000 tickets (25 per flight) at the unrestricted airfare of $220. All other data remain the same. Ignoring the information in requirement (b), how many discounted tickets would WSM have to sell annually to earn an operating income of $1,300,000? Assume that the annual number of flights remains at 1,400 and that the discounted tickets would be evenly divided across the 1,400 flights. Number of discount tickets Show less 3 Leidenheimer Corporation manufactures small airplane propellers. Sales for year 2 totaled $1,750,000. Information regarding resources for the month follows. Resources Used Resources Supplied Parts management Energy Quality inspections $ 56,000 $ 73,000 100,000 94,000 Long-term labor 54,000 100,000 109,000 72,000 Short-term labor 44,000 56,000 Setups 141,000 200,000 Materials 310,000 310,000 Depreciation 120,000 200,000 Marketing 139,000 163,000 Customer service 20,000 36,000 Administrative 112,000 134,000 In addition, Leidenheimer spent $40,500 on 45 engineering changes with a cost-driver rate of $900 and $56,000 on 8 outside contracts with a cost driver rate of $7,000. Required: Management has requested that you do the following: a. Prepare a traditional income statement. b. Prepare an activity-based income statement. Required A Required B Prepare a traditional income statement. Traditional Income Statement Total costs Required A Required B Prepare an activity-based income statement. Activity-Based Income Statement Costs Unit Batch Product and customer sustaining Capacity sustaining Total costs Resources Used Unused Resource Resources Supplied Capacity 2 Chocolate Bars, Inc. (CBI), manufactures creamy deluxe chocolate candy bars. The firm has developed three distinct products: Almond Dream, Krispy Krackle, and Creamy Crunch. CBI is profitable, but management is quite concerned about the profitability of each product and the product costing methods currently employed. In particular, management questions whether the overhead allocation base of direct labor-hours accurately reflects the costs incurred during the production process of each product. In reviewing cost reports with the marketing manager, Steve Hoffman, who is the cost accountant, notices that Creamy Crunch appears exceptionally profitable and that Almond Dream appears to be produced at a loss. This surprises both him and the manager, and after much discussion, they are convinced that the cost accounting system is at fault and that Almond Dream is performing very well at the current market price. Steve decides to hire Jean Sharpe, a management consultant, to study the firm's cost system over the next month and present her findings and recommendations to senior management. Her objective is to identify and demonstrate how the cost accounting system might be distorting the firm's product costs. Jean begins her study by gathering information and documenting the existing cost accounting system. It is rather simplistic, using a single overhead allocation base-direct labor-hours-to calculate and apply overhead rates to all products. The rate is calculated by summing variable and fixed overhead costs and then dividing the result by the number of direct labor-hours. The product cost is determined by multiplying the number of direct labor-hours required to manufacture the product by the overhead rate and adding this amount to the direct labor and direct material costs. CBI engages in two distinct production processes for each product. Process 1 is labor intensive, using a high proportion of direct materials and labor. Process 2 uses special packing equipment that wraps each individual candy bar and then packs it into a box of 24 bars. The boxes are then packaged into cases, each of which has six boxes. Special packing equipment is used on all three products and has a monthly capacity of 3,000 cases, each containing 144 candy bars (= 6 boxes x 24 bars). To illustrate the source of the distortions to senior management, Jean collects the cost data for the three products, Almond Dream, Krispy Krackle, and Creamy Crunch. Product costs Labor-hours per case Total cases produced Material cost per case Direct labor cost per case Labor-hours per product Total overhead = $78,500 Total labor-hours = 14,600 Direct labor costs per hour = $6.00 Allocation rate per labor-hour = (a). Costs of products Material cost per case Almond Krispy Creamy Dream Krackle Crunch 8.8 1,000 4.8 1,000 1.0 1,000 $ 9.80 $ 3.80 $ 10.30 $ 52.80 8,800 $ 28.80 $ 6.00 4,800 1,000 $ 9.80 Direct labor cost per case 52.80 $ 3.80 28.80 Allocated overhead per case (to be computed) Product cost (b) (e) (c) $ 10.30 6.00 (d) (f) (g) CBI recently adopted a general policy to discontinue all products whose gross profit margin percentages [(Gross margin + Selling price) 100] were less than 10 percent. By comparing the selling prices to the firm's costs and then calculating the gross margin percentages, Jean could determine which products, under the current cost system, should be dropped. The current selling prices of Almond Dream, Krispy Krackle, and Creamy Crunch are $103.00, $67.00, and $30.00 per case, respectively. Overhead will remain $78,500 per month under all alternatives. Required: a-1. Complete the table under the current cost system. a-2. Determine which product(s), if any, should be dropped. c-1. Assume that CBI drops the product(s) identified in requirement (a) above. Calculate the gross profit margin percentage for the remaining products. Assume that CBI can sell all products that it manufactures and that it will use the excess capacity from dropping a product to produce more of the most profitable product. c-2. If CBI maintains its current rule about dropping products, which additional products, if any, should CBI drop under the existing cost system? d-1. Assume that CBI drops the products identified in requirements (a) and (c) above. Recalculate the gross profit margin percentage for the remaining product(s) and ascertain whether any additional product(s) should be dropped. d-2. Which additional products, if any, should CBI drop under the existing cost system? Complete this question by entering your answers in the tabs below. Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 Complete the table under the current cost system. (Round your intermediate calculations and final answers to 2 decimal places. Negative values should be indicated with a minus sign.) Product costs: Labor-hours per case Total cases produced Material cost per case Direct labor cost per case Labor-hours per product Total overhead $ 78,500 Total labor-hours 14,600 Direct labor costs per hour $ 6.00 Allocation rate per labor-hour Costs of products: Material cost per case Direct labor cost per case Allocated overhead per case Product cost Selling price Gross profit margin percentage Almond Dream Krispy Krackle Creamy Crunch 8.80 4.80 1.00 1,000 1,000 1,000 $ 9.80 $ 3.80 $ 10.30 $ 52.80 $ 28.80 $ 6.00 8,800 4,800 1,000 69 $ 9.80 $ 3.80 $ 10.30 52.80 28.80 6.00 % % % Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 Determine which product(s), if any, should be dropped. Almond Dream OKrispy Krackle Creamy Crunch Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 Assume that CBI drops the product(s) identified in requirement (a) above. Calculate the gross profit margin percentage for the remaining products. Assume that CBI can sell all products that it manufactures and that it will use the excess capacity from dropping a product to produce more of the most profitable product. (Round your intermediate calculations and final answers to 2 decimal places.) Direct labor cost per hour Direct labor-hours per case Total cases produced Labor-hours per product Allocation rate per labor-hour: Allocated production costs: Material cost per case Direct labor cost per case Allocated overhead per case Product cost Gross profit margins: Selling price Product cost-direct labor allocation base Profit margin percentage % % Show less Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 If CBI maintains its current rule about dropping products, which additional products, if any, should CBI drop under the existing cost system? Almond Dream OKrispy Krackle Creamy Crunch Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 Assume that CBI drops the products identified in requirements (a) and (c) above. Recalculate the gross profit margin percentage for the remaining product(s) and ascertain whether any additional product(s) should be dropped. (Round your intermediate calculations and final answers to 2 decimal places.) Direct labor cost per hour Direct labor hours per case Total cases produced Labor hours per product Allocation rate per labor-hour: Allocated Production Costs: Material cost per case Direct labor cost per case Allocated overhead per case Product cost Gross profit margins: Selling price Product cost-direct labor allocation base Profit margin percentage % Req A1 Req A2 Req C1 Req C2 Req D1 Req D2 Which additional products, if any, should CBI drop under the existing cost system? Almond Dream Krispy Krackle Creamy Crunch 1 Skipped Utica Manufacturing (UM) was recently acquired by MegaMachines, Inc. (MM), and organized as a separate division within the company. Most manufacturing plants at MM use an ABC system, but UM has always used a traditional product costing system. Bob Miller, the plant controller at UM, has decided to experiment with ABC and has asked you to help develop a simple ABC system that would help him decide if it was useful. The controller's staff has identified costs for the first month in the four overhead cost pools along with appropriate cost drivers for each pool. Cost Pools Incoming inspection Production Machine setup Shipping Costs 237,000 1,350,000 720,000 468,000 Activity Drivers Direct material cost Machine-hours Setups Units shipped The company manufactures two basic products with model numbers 308 and 510. The following are data for production for the first month as part of MM. Total direct material costs Total direct labor costs Total machine-hours $ 45,000 $175,000 Products 308 510 $ 34,000 56,000 $205,000 94,000 Total number of setups 65 95 Total pounds of material 18,500 9,500 Total direct labor-hours Number of units produced and shipped 6,500 32,000 9,500 20,000 Required: a. The current cost accounting system charges overhead to products based on machine-hours. What unit product costs will be reported for the two products if the current cost system continues to be used? b. A consulting firm has recommended using an activity-based costing system, with the activities based on the cost pools identified by the cost accountant. What are the cost driver rates for the four cost pools identified by the cost accountant? c. What unit product costs will be reported for the two products if the ABC system suggested by the cost accountant's classification of cost pools is used? d. If management should decide to implement an activity-based costing system, what benefits should it expect? Required A Required B Required C Required D The current cost accounting system charges overhead to products based on machine-hours. What unit product costs will be reported for the two products if the current cost system continues to be used? (Round intermediate calculations and "Per unit cost" answers to 2 decimal places.) Total cost Per unit cost 308 510 Required A Required B Required C Required D A consulting firm has recommended using an activity-based costing system, with the activities based on the cost pools identified by the cost accountant. What are the cost driver rates for the four cost pools identified by the cost accountant? (Round your answers to 2 decimal places.) Incoming inspection Production Machine setup Shipping % of material dollars per machine-hour per setup per unit Required A Required B Required C Required D What unit product costs will be reported for the two products if the ABC system suggested by the cost accountant's classification of cost pools is used? (Round intermediate calculations and final answers to 2 decimal places.) Total cost Per unit cost 308 510 Required A Required B Required C Required D If management should decide to implement an activity-based costing system, what benefits should it expect? If management implemented an activity-based costing system it should be provided with a more thorough understanding of product costs. If management implemented an activity-based costing system it will increase the sales of the company.