Autotech Manufacturing is engaged in the production of replacement parts for automobiles. One plant specializes in the production of two parts: Part 127 and Part 234. Part 127 produces the highest volume of activity, and for many years it was the only part produced by the plant. Five years ago, Part 234 was added. Part 234 was more difficult to manufacture and required special tooling and setups. Profits increased for the first three years after the addition of the new product. In the past two years, however, the plant has faced intense competition, and its sales of Part 127 have dropped. In fact, the plant showed a small loss in the most recent reporting period. Much of the competition was from foreign sources, and the plant manager was convinced that the foreign producers were guilty of selling the part below the cost of producing it. The following conversation between Patty Goodson, plant manager, and Joseph Fielding divisional marketing manager, reflects the concerns of the division about the future of the plant and its products. Joseph: You know, Patty, the divisional manager is really concerned about the plant's trend. He indicated that in this budgetary environment, we can't afford to carry plants that don't show a profit. We shut one down just last month because it couldn't handle the competition. Patty: Joe, you and I both know that Part 127 has a reputation for quality and value. It has been a mainstay for years. Idon't understand what's happening. Joseph: I just received a call from one of our major customers concerning Part 127. He said that a sales representative from another firm offered the part at $20 per unit-- $11 less than what we charge. It's hard to compete with a price like that. Perhaps the plant is simply obsolete. Patty: No. I don't buy that. From my sources, I know we have good technology. We are efficient. And it's costing a little more than $21 to produce that part. Idon't see how these companies can afford to sell it so cheaply. I'm not convinced that we should meet the price. Perhaps a better strategy is to emphasize producing and selling more of Part 234. Our margin is high on this product, and we have virtually no competition for it. Joseph: You may be right. I think we can increase the price significantly and not loose business. I called a few customers to see how they would react to a 25 percent increase in price, and they all said that they would still purchase the same quantity as before. Patty: It sounds promising. However, before we make a major commitment to Part 234, I think we had better explore other possible explanations. I want to know how our production costs compare with those of our competitors. Perhaps we could be more efficient and find a way to earn our normal return on Part 127. The market is so much bigger for this part. I'm not sure we can survive with only Part 234. Besides, my production people hate that pa rt. It's very difficult to produce. After her meeting with Joseph, Patty requested an investigation of the production costs and comparative efficiency, She received approval to hire Sergeant Consulting Group to make an independent investigation. The staff accountant for Sergeant Consulting Group has uncovered the following costs and activities associated with the two products. Part 127 Part 234 Production 500,000 100,000 Selling Price $31.86 $24.00 Prime costs per unit $9.53 $8.26 Number of production runs 100 200 Receiving orders 400 1,000 Machine hours 125,000 60,000 Direct labor hours 250,000 22,500 Engineering hours 5,000 5,000 Material moves 500 400 Overhead is allocated using a plantwide rage based on direct labor hours. Preliminary analysis of costs by Sergeant Consulting Group revealed that similar costs can be categorized into the following cost pools. Setup costs are costs that occur each time a new production run is made. They involve retooling and reconfiguring the machines and technology. Material handling costs include the equipment and personnel required to transport materials from suppliertrucks to the machines. Typically, materials are taken to a storage area before being transported to machines. Each production run will need new materials and materials may also be transported during production runs. Machine costs primarily include depreciation and machine maintenance. Although the machines are depreciated using accelerated depreciation schedules, typicallythe machine wear out from use and are replaced before they become obsolete. Receiving costs include the costs of clerical and technical help associated with the processing of each order received from a customer. Engineering costs include the technical support staff that implement design changes in the part, manage processes to maintain quality, and provide technical information on the product. The engineering staff maintain a record of the amount of time spent on each product. General plant costs include all the other administrative costs not included in the other cost pools. Overhead Cost Pools Setup costs $240,000 Material handling costs 900,000 Machine costs 1,750,000 Receiving costs 2,100,000 Engineering costs 1,500,000 General plant costs 500 000 Total $6,990,000 (This case is taken from Hansen, Mowen and Guan, \"Cost Management: Accounting and Control\" sixth edition, South-Western Cengage Learning, 2009, problem 4-17, pp. 122-123.) Part 1: Compute overhead and gross margin using traditional costing Part 2: Part 3: ABC Project-Analysis Per Unit Part 127 Part 234 Overhead/unit Gross Margin: Selling Price/unit Prime costs/unit Overhead/unit Gross margin/unit Total 10me Part 127 11>me Part 234 Total Profit 5 Select the best cost driver and compute overhead rates for each cost pool, Cost pool Setup costs Cost Driver Overhead rate Material handling costs Machine costs Receiving costs Engineering costs General plant costs 5 S S $ $ $ Compute overhead and gross margin using Activitybased Costing Per Unit Part 127 Part 234 Overhead/unit Gross Margin: Selling Price/unit Prime costs/unit Overhead/unit Gross margin/unit Total Total Profit S inme Part 127 10me Part 234