Beaver Co. is a publicly traded corporation that produces different types of air fryers. My name is Alan Smith and I have worked for this company for the last ten years in the controllers office. I was both an accounting and finance major in university. The company currently produces 300 products and does not anticipate any new products coming out over the next three years. I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional costing system (where overhead costs are allocated across products at a rate of $30 per direct labor hour) when different products require different amounts of indirect overhead resources. For example, under the traditional system all costs associated with testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor hours. Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor hours. Given that traditional costing systems may result in significant cost distortions when determining products costs and given that the firm now has revenues of over $100 million a year, Beaver has decided to adopt activity based costing over the next year or two.

Beavers management has hired Deloitte Consulting to help us implement activity based costing. I will be acting as the liaison between our firm and Deloitte. As part of the initial implementation phase, I have asked Deloitte to derive the costs and product margins associated with two of our products, Classic and Artisan, so that these costs and product margins could be compared with the costs and profit margins under our current traditional costing system. I picked these products since Beaver management believe they have very different demands on indirect overhead resources. Further, Classic is sold in large quantities whereas Artisan is sold in small quantities.

Current information from our existing system on a per unit basis is shown in Exhibit 1.

Exhibit 1

	Classic	Artisan
Direct material	$20	$40
Direct labor hours	1.5	2
Direct labor wage rate per hour	$15	$15
Sales price per unit	$100	$150

My staff has identified for Deloitte five activity cost pools. Information on those cost pools and the related activity measures are provided in Exhibit 2.

Exhibit 2

	Total Costs	Allocation Base	Level of Allocation Base
Equipment setups	$4,000,000	number of setups	50,000
Purchase orders	$2,000,000	number of purchase orders	20,000
Machining	$5,000,000	number of machine hours	80,000
Testing	$7,000,000	number of testing hours	250,000
Packaging and shipping	$6,000,000	number of containers	300,000

Although fixed costs are lumped in with variable costs across the five different cost pools, I am aware that machining related costs consists almost exclusively of depreciation costs. Hence, with respect to all questions asked in this case, machining costs will be treated as entirely fixed with respect to machine hours. Each machine is used in the production of multiple product lines. The resale value of machines is only affected by the passage of time and not by how much they are used in a given year.

In all questions asked in this case, the firm will assume that costs associated with equipment setups, purchase orders, testing, and packaging & shipping are variable with respect to their respective activity measures. Currently, we believe our assumptions on cost behavior patterns are quite reasonable.

All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors.

Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the firm never has a beginning or ending work in process inventory, and it does not have a beginning or ending finished goods inventory.

Further information on our two products is provided in Exhibit 3

Exhibit 3

	Classic	Artisan
annual sales and production in units	500,000	80,000
number of units per batch	400	50
number of purchase orders	500	320
number of machine hours per unit	0.6	1
total number of testing hours	30,000	50,000
total number of containers	1,200	4,000

QUESTION :

Question 6 is independent of question 5. Next year, because of an expected increase in product demand, machine hours are expected to increase from 80,000 to 200,000. The company will not need any new machinery since the current machinery is highly underutilized. Also, the number of testing hours will increase from 250,000 to 400,000. Assume that these new levels of operations are within the firms relevant range. Calculate what the activity rate for the cost pool of machining would be next year if it can be calculated. Also, calculate what the activity rate for the cost pool of testing would be next year if it can be calculated. If one or both rates cannot be calculated, then explain in words why the calculations cannot be determined in the absence of more information. Excluding any quantitative analysis, your explanation should not be more than 1/3 page double spaced with 12 font.

bit 1 Classic Artisan $20 $40 Exhibit 1 Direct material Direct labor hours Direct labor wage per hour Sales price per unit 1.5 $15 $100 2. $15 $150 Exhibit 2 Equipment setups Purchase orders Machining Testing Packaging and shipping 50 Exhibit 3 Annual sales in units Units per batch Number of purchase orders Number of machine hours per unit Number of Testing hours Number of containers Number of batches Total Costs Allocation Base Level of Allocation Base Calculated: $4,000,000 # setups 50,000 $80 per setup $2,000,000 #purchase order 20,000 $100 per order $5,000,000 # machine hours 80,000 $63 per machine hour $7,000,000 # testing hours 250,000 $28 per testing hour $6,000,000 # containers 300,000 $20 per container Machining costs fixed, testing costs are variable Classic Artisan Statements Classic Artisan 500,000 80,000 Sales $50,000,000 $12,000,000 400 DM 10,000,000 3,200,000 500 320 DL 11,250,000 2,400,000 0.6 Equipment setup 100,000 128,000 30,000 50,000 Purchase orders 50,000 32,000 1,200 4,000 Machining 18,750,000 5,000,000 1250 1600 Testing 840,000 1,400,000 Packaging and sl 24,000 80,000 Classic Artisan Total ABC Costs $41,014,000 $12,240,000 $50,000,000 $12,000,000 Product Margin $8,986,000 -$240,000 $10,000,000 $3,200,000 AVG product mai $18 $11,250,000 $2,400,000 $22,500,000 $4,800,000 $43,750,000 $10,400,000 $6,250,000 $1,600,000 $13 $20 -$3 Statements Sales DM DL MOH COGS Margin Avg margin per unit One setun ner hatch