CASE 6-2 QUANTUMTM [LO 2] QuantumTM manufactures electronic testing and mea- device and an order for 1 harmonic analyzer. The costs and prices surement instruments. Many products are custom-designed charged were as follows: with recent orders for function generators, harmonic analyzers, logic analyzers, temperature measurement instruments, and Temperature Harmonic data-logging instruments. The company prices its instruments Monitor Analyzer at 30 percent over estimated cost (excluding administrative and Component cost per unit $ 250 $2,500 selling costs). 25 500 Recently, senior management has noted that its product mix Direct labor per unit has changed. Specifically, the company is receiving fewer large Overhead per unit 120 2,500 orders for instruments that are relatively simple to produce, and Cost per unit 395 5,500 customers are saying that the company is not price competi- Markup at 30% 119 1,650 tive. The company is, however, receiving more small orders for Price per unit $ 514 $7,150 complex instruments, and customers appear quite happy to pay Number of units 900 QuantumTM's price. This situation was discussed at a weekly Value of order $462,600 $7,150 management meeting. Jason Norton, VP of operations, blamed the company's antiquated cost accounting system. "Look," he said, "if you have bad cost information, you're going to have bad prices, In the current system, overhead is applied based on an estimate of and we're still doing product costing the way companies did it in $50,000,000 of annual overhead and $10,000,000 of direct labor the 1930s. I've been reading articles about activity-based costing, cost. The consultants have broken the $50,000,000 of annual over- and they indicate that out-of-date costing systems make simple head down into six cost pools and identified related cost drivers products look too costly and complex products too cheap. If that's as indicated in Exhibit 1. The consultants have also found that the true, it would explain why we're not price competitive for simple monitor and analyzer make use of the cost drivers as indicated in products." Exhibit 2. The meeting ended with a decision to hire a consultant to con- duct a preliminary ABC study to determine how a switch to ABC REQUIRED would affect product cost. The consulting firm selected two recent a. Based on the consultants' work to date, calculate the ABC cost orders for study: a 900-unit order for a temperature-monitoring per unit of each product.b. The consultants have completed their job, and QuantumTM c. Suppose QuantumI'M meets its competitor's price and gets has adopted an ABC system as indicated in Exhibit 1. Recently, the job. What will be the impact on company profit? In answer- the company received an order for a unique data-logging device. ing this question, make the following assumptions: The device will require $9,000 of components and $3,000 of direct labor along with the following requirements 1. 40 percent of design costs are fixed, and 60 percent vary with design hours. 2. 30 percent of material ordering and handling costs are Use related to a data logging device: fixed, and 70 percent vary with the number of unique parts. Number of design hours 27 3. 50 percent of inspection costs are fixed, and 50 percent Number of unique parts 17 are variable. Number of inspections 12 4. 80 percent of setup costs are fixed, and 20 percent are Number of setups 1 variable. Machine hours 10 5. 20 percent of labor-related costs are fixed, and 80 percent are variable. The customer has indicated that it currently has a low bid 6. Prices charged to this customer or other customers in the from another company of $22,000. Calculate the ABC cost of the future will not be impacted by the current deal. This fol- data-logging device. lows because each order is unique. EXHIBIT 1 Cost Pools Annual Cost Annual Driver Value Cost pools and drivers Product design $ 8,000,000 160,000 design hours Material ordering and handling 10,000,000 125,000 unique part's Inspection 3,500,000 560,000 inspections Setup 2,500,000 80,000 setups Labor-related overhead 8,000,000 $10,000,000 direct labor Depreciation of plant and equipment 18,000,000 225,000 machine hours $50,000,000 EXHIBIT 2 The following values relate to the entire order The following values relate to the order for Use of cost driver of 900 monitors (this is not per monitor): 1 analyzer: Number of design hours 47 Number of design hours 110 Number of unique parts 17 Number of unique parts 25 Number of inspections 225 Number of inspections 20 Number of setups Number of setups Machine hours 112 Machine hours