CableTech Bell Corporation (Cl'B) operates in the telecommunications industry. CI'B has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 35 additional channels and two movie channels; and a premium package, which is the basic package plus 55 additional channels and six movie channels. The Cable Service Division reported the following activity for the month of March: Bas Enhanced Prem um Sales (units) 50,000 500,000 300,000 Price per unit $32 $60 $90 Unit costs: Directly traced '6 $18 '36 Driver traced $4 $8 $12 Allocated $20 $26 $30 The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing Typically, the division uses only production costs to dene unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Voungers, the president of GTE, is reasonably satised with the performance of the Cable Service Division. March's performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March's dismal performance was also typical for what has been happening this year and is expected to continue unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: Inventories: Materials, March 1 $23,000 Materials, March 31 40,000 Work in process, March 1 130,000 Work in process, March 31 45,000 Finished goods, March 1 480,000 Finished goods, March 31 375,000 Costs: Direct labor $117,000 ..:::2.;:::eq\""m"' Materials handling 85,000 Inspections 60,000 Scheduling 30,000 Power 30,000 Plant supervision 12,000 Manufacturing engineering 21,000 Sales commissions 120,000 Salary, sales supervisor 10,000 Supplies 17,000 Warranty work 40,000 Rework 30,000 During March, the Phone Division purchased materials totaling $312,000. There are no signicant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. ch's Phone Division had sales totaling $1,170,000 for March. Based on March's results, Bryce decided to meet with three of the Phone Division's managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: \"March's prot performance is down once again, and I think we need to see if we can identify the problem and correct itibefore it's too late. Kim, what's your assessment of the situation?" Ki "Foreign competition is eating us aliveselling phones at a lower price and high quality. If we could lower our prices by 10 to 15 percent, 1 think that we'd regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I'd like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we my\": i-iaiciis piuiii. paiiuiiiioiica ia uwvii uiic: dgaiii, aiiu i uiiiin Wt. iiaau w a== ll v1: coil iu=iiuiy i.ii= uiuuiaiii aiiu cuiiau iLuaiuia ii. e um iota. l\\llll, midi. a yuui aaeaaaiiiaiit ui i.ii= aiwauwi: Kim: "Foreign competition is eating us aliveselling phones at a lower price and high quality. if we could lower our prices by 10 to 15 percent, 1 think that we'd regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. We are spending a lot of money each month on inspection, rework, and warranties. I'd like to see these costs cut by at least 50 percent. If we could do that by improving quality, then customers would be more satisfied with our products, and we would not only regain our market share but increase it." Larry: \"They're right. If we could lower our prices by 10 to 15 percent, 1 think that we'd regain most of our lost market share. But we also need to make sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worries me. I'd like to see that warranty cost cut by 70 to 80 percent. If We could do that, then customers would be more satised with our products, and I bet that We would not only regain our market share but increase it.\" Jacob: \"Lowering prices Without lowering perrunit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know hoW much each of our product lines is costing us. It may be that we are overprlcing some of our units because we are overcosting them. We may be underprlcing other units.\" |arry: \"This sounds promisingeespecially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest differenceeand if we knew they were over-costed, then we could offer immediate price reductions.\" Bryce: \"Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?\" Jacob: \"1 think that our manufacturing environment has changed. over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We traceor attempt to traceoverhead costs to the different products Using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don't have a very good idea of our aaual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information information that will allow us to assign costs more accurately." Bryce: \"This may be something we should explore. Jacob, what do you suggest?\" Jacob: \"If we Want more accurate product costs and if we really Want to get in the cost reduction business, then we need to understand how costs behave. In particular, We need to understand activity cost behavior. Knowing What activities We perform, why we perform them, and how well we perform them Will help us identify areas for improvement. We also need to know how the different products consume activity resources. what this boils down to is the need to use an activityrbased management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. 5o 1 suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unit- drivers might be needed. In fact, if you would like, I can gather some data that Will provide some eVIdence on the usefulness of the actiVItyrbased approach." Bryce: "What do you think, Kim? It's your division.\" Kim: \"what Jacob has said sounds promising. 1 think he should pursue it and do so quickly. 1 also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I'll talk to our quality people. Jacob, in the meantime, nd out for us if moving to an activity-based system is the way to go. How much time do you need?\" Jacob: \"1 have already been gathering data. 1 could probably have a report within two weeks." MEMO T0: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, 1 am condent that an ABC system will offer signicant improvement. For one of our conventional phone plants, 1 regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: Overhead Direct Labor Cost $360,000 $110,000 300,000 100,000 350,000 90,000 400,000 100,000 320,000 90,000 380,000 100,000 300,000 90,000 230,000 90,000 340,000 95,000 410,000 115,000 375,000 100,000 360,000 85,000 340,000 85,000 330,000 90,000 300,000 80,000 The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn't explain a lot of the variation. 1 then searched for other driversparticularly non-unit driversthat might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn't provide the number of moves, so I The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn't explain a lot of the variation. I then Searched for other driversparticularly nonsunit driversthat might offer more insight into overhead cost behavior. Every time a batch is produced, maternal movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our Information system doesn't provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: Handling Cost Number of Moves $80,000 1,500 60,000 1,000 70,000 1,250 72,000 1,300 55,000 1,100 35,000 1,700 67,000 1,200 73,500 1,350 83,000 1,400 34,000 1,700 The regression results were impressive There is no question in my mind that the number of moves is a good driver of materialshandling costs. Using the number of moves to assign materialshandling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be overcosting our high-volume products Kim, you expressed the desire of reducing the costs of inspection, reworking, and warranties, In addition to the pilot study for one plant, 1 also collected information about these three activities for the division, For the inspection activity, we have 15 inspectors who are paid an average of 54,000 per month. Each inspector offers a practical inspection capaCIty of 2,000 hours per yearo However, it appears that inspectors actually work only about 80 percent of those hours. Rework cost is simply the cost of replacmg some faulty components and the associated direct labon The rework cost per unit is predictable and constant per unit regardless of the product model. Warranty cost, on the other hand, involves the salaries of two technicians, with the remaining cost, the cost of replacement components, which is relatively constant per unit repaired. The technicians are paid $5,000 per month and provide 2,000 hours of service per year. Warranty Service usually requires 3,600 technician hours per year. After receiving the memo, Kim was intrigued, both by the activity-based costing pilot study and by the potential sayings for the division by improving quality. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant's two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled \"other manufacturing activities.\" From the special study already performed, she knew that materials handling and inspecting involved significant Cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: _ _ Expected , Activity Actnnty Co\" Driver Capaciw Other activities $2,000,000 D're\" lab\" $1,250,000 dollars Moving materials 900,000 Number f 18,000 MOVES inspecting 720,000 \"swam" 24,000 hours Reworklng 300,000 Rework hours 3,000 Total overhead cost $4,000,000 Expected activity demands: Regu rMode D uxe Model Units completed 100,000 40,000 Direct labor dollars $075,000 $375,000 Number f 7,200 10,800 mOVeS \"Spam\" 5,000 13,000 hours Rework hours 1,900 1,900 Expected activity demands: Regular Model Deluxe Model Units completed 100,000 40,000 Direct labor dollars $875,000 $375,000 Number of 7,200 10,800 moves Inspection 6,000 18,000 hours Rework h 1,900 1,900 Required: 1. Answer the following regarding the product costing system of the Cable Service Division: a. Complete the following table with the appropriate product costs for the Cable Service Division: Round the answers to two decimal places. Basic Enhanced Premium Product cost for 30 52 78 pricing Product cost for cost of services sold The product cost for the pricing decision includes all production, marketing, and customer service costs. There may be, and very likely is, very little R&D function in the Cable Service Division. Thus, this first v unit cost could be used for other managerial objectives, such as product mix decisions and strategic and tactical profitability analysis. The second v cost includes only production costs; complying with external financial reporting guidelines is the primary managerial objective of this method. b. Allocation relies on: assumed linkages or convenience to assign costs. c. Direct tracing relies on: exclusive physically observable causal relationships to assign costs. d. Driver tracing relies on: causal factors to assign costs. e. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based costing system? functional-based Feedback Check My Work 1. Total unit costs provided. Use percentage given to multiply by total unit costs to determine cost of services sold. 2. Prepare an income statement for the Cable Service Division for March. Cable Service Division Income Statement For the Month of March Sales revenue Cost of services sold Gross margin Less: Operating expenses Income before income taxes Feedback Check My WorkPrepare an income statement for the Phone Division for March. Phone Division Income Statement For the Month of March Sales $ Cost of goods sold: Beginning finished goods inventory Add: Cost of goods manufactured Goods available for sale Less: Ending finished goods inventory Gross margin Less: Selling expenses Income before income taxes Feedback Check My Work Partially correct For the income statement associated with the Phone Division, include a supporting cost of goods manufactured statement. Phone Division Statement of Cost of Goods Manufactured For the Month of March Direct materials: Beginning inventory Add: Purchases Materials available Less: Ending inventory Direct materials used Direct labor Overhead Plant and equipment depreciation Materials handling Inspections Scheduling 00000000 Power V Plant supervision Manufacturing engineering Supplies V Rework Total manufacturing costs added: Add: Beginning work in process Less: Ending work in process Cost of goods manufactured3. Review Exhibit 2.5. Now consider the concern that Jacob has expressed about the costing practices of the Phone Division. Also consider the directives that Kim gave Jacob and his resulting actions. Now answer the following: a. What is Jacob attempting to measure? Jacob is primarily focused on the groduct costing model v v used by the Phone Division. He wants to ensure that the unit costs are v accurate and meaningful. b. Why is he attempting to measure it? Jacob wants to accurately v v measure unit cost so that better pricing decisions can be made and so that the division can v v better understand how to reduce v v costs to improve profitability. c. How is it currently being measured, and how will the measurement approach change? The current costing model assigns prime costs by direct tracing and overhead costs using a single unit-level drivernamely direct labor costs v v . Jacob is arguing that the single driver is really more v y allocation than tracing and that the unit overhead cost may be . overcosting some products, leading to overpricing those products. He is suggesting that activity-based costing will likely lead to more accurate cost assignments. d. Where did Jacob get the data needed to carry out the proposed analyses? Jacob gathered a sample of data from one of the division's conventional V y phone plants. e. which analytic methods did Jacob use or propose to be used? Jacob used regression V x/ analysis to show that direct labor cost, the single unit-level driver, did not V x/ explain much of the Variability in overhead cost. He also used the same method to Show that a non-unit-Ievel driver, number of moves, was a good driver of material handling costs. Taken together, the results suggested the viability of using activity-based costing, a product costing analytical model. r. when will the analysis be completed and ready for decision making? Some of the analysis, such as the results of the two regressions, was V y completed and led to the direction by Kim to expand the analysis to a pilot study of ABC at the same conventional phone plant. The actual results of the pilot study were not V y yet fully completed but pending. 9. Who needs to understand the analysis done by Jacob, and how was it or will it be communicated? Jacob has already communicated some of his analyses to key d nal a ers v y . The results of the ABC pilot study, when communicated, will then set the stage for a decision to be made by the three v y divisional ofcers. 4. Using a regression program such as Microsoft Excel, calculate two cost formulas: (1) overhead using direct labor cost as the driver and (2) materials handling cost using number of moves as the driver. Based on the outcomes, answer the followmg: Round the intercept to the nearest dollar and round the slope to the nearest cent. a. Formula one, Direct labor cost formula: Y = s + s x intercept (rounded to nearest dollar): $ Slope (Coefficient 1, rounded to the nearest cent): 5I: R Square (rounded to two decimal places): $ b. Formula for material handling cost (based on number of moves): Y : $ + $ X Intercept (rounded to nearest dollar): $ Slope (Coefficient 1, rounded to the nearest cent): $ R Square (rounded to two decimal places): $ c. The intercept can be interpreted as: ed cost. V \\/ d. Coefcient 1 can be interpreted as: variable cost per unit. V y e. Comment on Jacob's observations concerning the outcomes Jacob's comments seem to be on target. Direct labor cost v v explains less than 40 percent of the variability in overhead costnot enough to justify using Direct labor cost ' V as the only driver to trace overhead to individual products. The number of moves v V a non-unit driver, explains 90 percent of the materials handling cost variability. Using the number of moves v v to assign materials handling cost appears reasonable and certainly better than using direct labor cost to assign this cost. In fact, as small batches use the same moves . v as large batches but much less labor, large batches are receiving too much materials handling cost. Thus, some evidence exists that high-volume products are overcosted . v. 5. Answer the following: a. Inspection is a stepfixed v v cost, with each step v v being dened by inspection hours per year. Each step v v costs 3 . Current activity capacity for inspection is hours. Current demand for the inspection activity is hours. b. Rework is a: variable cost. ' V 1:. Warranty is a: xed cost. V V d. Assume that quality improves so that the current demand for the output of the inspection, rework, and warranty activities drops by so percent (with the Phone Division capturing all savings possible by reducing the resources currently used by the activities). Calculate the increase in March's prertax operating income produced by the savings. March income would increase by the amount is $ 6. Using the data generated by Jacob's pilot for a preliminary ABC analysis, answer the following: a. Calculate the overhead cost per unit for each phone model using direct labor cost to a55ign all overhead costs to products (round overhead rate to two decimal places). Overhead Cost per u it Regular 3 Deluxe s b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identified by Jacob (round activity rates to two decimal places). Rates Other: per direct labor dollar Moving: 3 per move Inspecting: 5 per inspection hour Reworking: s per rework hour U Cost Regular $ Deluxe 3 c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently overstated ' V by $ d. If the unit product cost of the Regular model is overstated v v, then the selling price could be decreased v v, making the company more v v competitive. 7. Suppose that Jacob learned about duration-based costing after completing the pilot study, According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hourt Calculate the unit cost for each model using duration-based costing. The unit Costs of the Regular Models is $ The unit costs of the Deluxe Models is $ How do unit costs compare to the ABC costs? DBC is much simpler and less ' V Custly to use than ABC and produces about the same unit costs. Deluxe 3 b. Calculate the overhead cost per unit for each phone model using the four activities and drivers identied by Jacob (round activity rates to two decimal places). Activity Rates Other: per direct labor dollar Moving: g; per move Inspecting: gs per inspection hour Reworking: s per rework hour Unit Cost Regular $ Deluxe $ c. Using the ABC assignments as the benchmark, the unit manufacturing cost for the Regular model is currently overstated ' V by $ d. If the unit product Cost of the Regular model is overstated V V , then the selling price could be decreased ' V , making the company more ' V competitive. 7, Suppose that Jacob learned about durationcbased costing after completing the pilot study. According to the plant manager of the phone plant used for the pilot study, the cycle time for the Regular model is 0.50 hours and that of the Deluxe model is one hour, Calculate the unit cost for each model using duration-based costing. The unit costs of the Regular Models is s The unit costs of the Deluxe Models is $ How do unit costs compare to the ABC costs? BBC is much simpler and less v v costly to use than ABC and produces about the same unit costs. Which approach would you recommend to Kim? DEC ' V should be recommended, 8. Review Exhibit 2.6. Now consider the use of the regression model in the memo submitted by Jacob. Which of the four data analytic types (descriptive, diagnostic, predictive, and prescriptive) apply to the use of the regression model? Note: More than one may apply. Explain your choice(s). Both applications are certainly descriptive v y, telling what is. The first describes the relationship between total overhead and direct labor cost. The second describes the relationship between material handling cost and the number of moves. The next step, though, in using the models is assessing why. The low correlation between overhead and direct labor cost suggests the inadequacy of using only direct labor cost to assign overhead costs to individual products. The strong correlation between material handling costs and number of moves reinforces this diagnosis. Thus, there is clearly a diagnostic . y role for the regression results as well. The two results taken together provide evidence that a more sophisticated costing model needs to be used, and so you could argue for a prescriptive . v role as well. Feedback , Check My Work 4. Use regression statistics to determine formulas. Use coefcients provided for the Intercept and Slope (X Variable 1). 6. Calculate overhead rate for each unit Allocate Overhead costs using Overhead rate Total overhead costs Divide by number of units to calculate unit Overhead cost. Then, calculate activity rates by dividing cost by usage. Allocate Overhead using activity rates. Total Overhead costs. Divide by number of units to calculate unit Overhead cost. 7. Calculate total hours by multiplying cycle time by units of product. Total hours for both products. Use totals to calculate capacity rate, Multiply capacity rate by cycle time to calculate unit cost for each product. Feedback . Check My Work Partially correct