Companies formulate accounting systems to make better management decisions. This case study can provide you the chance to compare different accounting methods to allocate the overhead costs. Read carefully the case and answer the required questions. Don't forget to write a memo to the company president. Traditional VS. Activity-Based Costing Methods ABC Corporation manufactures electric pumps and their three product models are regular, advanced, and deluxe. The company has been using a job-order cost method to apply manufacturing overhead costs to each model. The allocation is on the basis of direct-labor hours. The following is the information about the company's product costs and annual sales. Annual Sales (units) Regular Model 20,000 $20 Advanced Model 1,000 $50 Deluxe Model Product Costs: Direct Material 10,000 $84 Product Costs: Direct Labor 20 (1 hr at $20) 40 (2 hr at $20) 40 (2 hr at $20) Product Costs: 170 (1 hr at $170) 340 (2 hr at $170) 340 (2 hr at $170) Manufacturing Overhead* Total Product Cost $210 $430 *The calculation of the predetermined overhead rate is as follows: Manufacturing-Overhead Budget Manufacturing Overhead Depreciation, machinery Amount $2,960,000 Maintenance, machinery 240,000 Depreciation, taxes, and insurance for factory 600,000 Engineering 700,000 Purchasing, receiving, and shipping 500,000 Inspection and repair of defects 750,000 $464 Manufacturing-Overhead Budget Manufacturing Overhead Amount Depreciation, machinery $2,960,000 Maintenance, machinery 240,000 Depreciation, taxes, and insurance for factory 600,000 Engineering 700,000 Purchasing, receiving, and shipping 500,000 Inspection and repair of defects Material handling Miscellaneous manufacturing overhead costs 750,000 800,000 590,000 Total $7,140,000 Direct-Labor Budget Page 1 of 3 Direct-Labor Budget Model Regular Model Advanced Model Deluxe Model Total Time 20,000 hours 2,000 hours 20,000 hours 42,000 hours Predetermined overhead rate: budgeted overhead divided by budgeted direct-labor hours $7,140,000 divided by 42,000 hours = $170 per hour Hilton, R. W. (2013). Managerial accounting: creating value in a dynamic business environment. Retrieved from http://connect.mheducation.com/connect/hmInstructorSection HomePortal.do?sectionId= 38690402 For the last 10 years, the company set each model's target price at 110 percent of its full product cost. However, ABC Corporation realized that the regular-model pump has come under increasing price pressure from offshore competitors. The result was that the price on the regular model has been lowered to $220. When the company president had a meeting with a controller, the president expressed his concerns; "Why can't we compete with these other companies? They're selling pumps just like our regular model for $212. That's only two bucks more than our production cost. Are we really that inefficient? What gives?" The controller responded by saying, "I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean." Getting the president's go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line. Activity Cost Pool Cost Driver Product Lines' Product Product Lines' Lines Getting the president's go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line. Activity Cost Pool Cost Driver Model Product Product Product Lines: Lines: Lines: Regular Advanced Deluxe Model Model I: Depreciation, machinery Maintenance, machinery Machine time 39% 13% 48% II: Engineering Inspection and repair of defects Engineering hours 47% 6% 47% Page 2 of 3 III: Purchasing, receiving, and shipping Material handling Number of material orders 47% 8% 45% IV: Depreciation, taxes, and insurance for factory Factory space usage 42% 15% 43% Miscellaneous manufacturing overhead Hilton, R. W. (2013). Managerial accounting: creating value in a dynamic business environment. Retrieved from http://connect.mheducation.com/connect/hmInstructorSection HomePortal.do?sectionId= III: Purchasing, receiving, and shipping Material handling Number of material 47% orders 8% 45% IV: Depreciation, taxes, and insurance for factory Factory space usage 42% 15% 43% Miscellaneous manufacturing overhead Hilton, R. W. (2013). Managerial accounting: creating value in a dynamic business environment. Retrieved from http://connect.mheducation.com/connect/hmInstructorSection HomePortal.do?sectionId= 38690402 Required: 1. Compute the target prices for the three pump models, based on the traditional, volume-based product-costing system. 2. Compute new product costs for the three products, based on the new data collected by the controller. Round to the nearest cent. 3. Calculate a new target price for the three products, based on the activity-based costing system. Compare the new target price with the current actual selling price for the regular model pump. 4. Write a memo to the company president explaining what has been happening as a result of the firm's traditional volume-based product-costing system. 5. What strategic options does management have? What do you recommend, and why