5-40 Activity-Based Costing; Customer Group Cost Analysis Franklin Inc. (FFI) manufactures bedroom furniture in sets (a set includes a dresser, two queen-size beds, and one bedside table) for use in motels and hotels. FFI has three customer groups, which it calls the value, quality, and luxury groups. The value products are targeted to low-price motels that are looking for simple furniture, while the luxury furniture is targeted to the very best hotels. The value line is attractive to a variety of hotels and motels that appreciate the combination of quality and value. Currently there has been a small increase in the quality and value lines, and an appreciable increase in demand in the luxury line, reflecting cyclical changes in the marketplace. Luxury hotels are now in more demand for business travel, while a few years ago, the value segment was the most popular for business travelers. FFI wants to be able to respond to the increased demand with increased production but worries about the increased production cost and about price setting as its mix of customers and production change. FFI has used a volume-based overhead allocation rate based on direct labor hours for some time. Direct labor cost is $15 per hour. Materials Handling Product Scheduling Setup Labor Automated Machinery Finishing Pack and Ship General, Selling, and Adm. Costs Budgeted Cost $ 349,600 160,000 216,000 1,750,000 619,500 290,400 $3,385,500 $5,000,000 Cost Driver Number of Parts Number of Production Orders Number of Setups Machine hours Direct Labor Hours Number of orders Shipped The budgeted production data for the three product lines follow. Product Lines Sets produced Price Direct material cost per set Number of parts per set Direct labor hours per set Machine hours per set Production orders Production setups Orders shipped Number of inspections Value Quality Luxury 15,000 5,000 600 $650 $900 $1,200 $80 $50 $110 30 50 120 4 5 7 3 7 15 50 70 200 20 50 50 1,000 2,000 300 2 6 14 Required (Round all activity rates and unit costs to two decimal places) 1. Determine the cost per set and the total production cost of each of the three customer groups using activity-based costing. 2. Determine the production cost for each of the three customer groups using FFI's current volume-based approach. 3. Compare the two approaches and discuss the strategic and competitive issues of using each of the two methods. 4. The activity usage data given in the problem reflects current usage of various cost drivers to manufacture the firm's product lines. Suppose you are given the following information regarding the firm's practical capacity for each of these activities, as follows: Cost Driver Number of Parts Number of production orders Number of setups Machine hours Direct labor hours Number of orders shipped Practical Capacity 990,000 800 200 100,000 123,900 5,000 Compute the new activity rates using practical capacity and comment on how you would use this additional information for costing the firm's products and assisting in strategic planning.