Depending on the information in the picture
Identify two reasons why an activity-based costing system may be appropriate for Wall Dcor.
The Business Situation Mr Burns, president of Greetings Inc., created the Wall Decor unit of Greetings three years ago to increase the company's revenue and profits. Unfortunately, even though Wall Decor's revenues have grown quickly, Greetings appears to be losing money on Wall Decor: Mr. Burns has hired you to provide consulting services to Wall Decor's management. Your assignment is to make Wall Decor a profitable business unit. Your first step is to talk with the Wall Decor work force. From your conver sations with store managers you learn that the individual Greetings stores are very happy with the Wall Decor arrangement. The stores are generating additional sales revenue from the sale of unframed and framed prints. They are especially enthusiastic about this revenue source because the online nature of the product enables them to generate revenue without the additional cost of carrying inven. tory, Wall Dcor sells unframed and framed prints to each store at product cost plus 20%. A 20% markup on products is a standard policy of all Greetings inter company transactions. Each store is allowed to add an additional markup to the unframed and framed print items according to market pressures. That is, the sell- ing price charged by each store for unframed and framed prints is determined by each store manager. This policy ensures competitive pricing in the respective store locations, an important business issue because of the intense mall competition. While the store managers are generally happy with the Wall Decor products, they have noted a significant difference in the sales performance of the unframed prints and the framed prints. They find it difficult to sell unframed prints at a competitive price. The price competition in the malls is very intense. On average, stores find that the profits on unframed prints are very low because the cost for unframed prints charged by Wall Decor to the Greetings stores is only slightly below what competing stores charge their customers for unframed prints. As a result, the profit margin on unframed prints is very low, and the overall profit earned is small, even with the large volume of prints sold. In contrast, stores make a very good profit on framed prints and still beat the nearest competitor's price by about 15%. That is, the mall competitors cannot meet at a competi- tive price the quality of framed prints provided by the Greetings stores. As a re- sult, store managers advertise the lowest prices in town for high-quality framed prints. One store manager referred to Wall Decor's computer on the counter as a "cash machine for framed prints and a "lemonade stand" for unframed prints. In a conversation with the production manager, you learned that she believes that the relative profitability of framed and unframed prints is distorted because of improper product costing. She feels that the costs provided by the company's traditional job order costing system are inaccurate. From the very beginning, she has carefully managed production and distribution costs. She explains, "Wall Dcor is essentially giving away expensive framed prints, and it appears that it is charging the stores too much for unframed prints. In her office she shows you her own product costing system, which supports her point of view. Your tour of the information technology (IT) department provided additional insight as to why Wall Decor is having financial problems. You discovered that to keep the website running requires separate computer servers and several infor mation technology professionals. Two separate activities are occurring in the technology area. First purchasing professionals and IT professionals spend many hours managing thousands of prints and frame and matting materials. Their tasks include selecting the prints and the types of framing material to sell. They also must upload, manage, and download prints and framing material onto and off of the website. The IT staff tells you much of their time is spent with framing and matting material. Only a highly skilled IT professional can properly scan a print and load it up to the site so that it graphically represents what the print will look like when properly matted and framed. In addition, you discover that a different team of IT professionals is dedicated to optimizing the operating performance of the website. These costs are classified as manufacturing overhead because a substantial amount of work is required to keep the site integrated with purchasing and production and to safeguard Wall Decor's assets online. Most time-consuming is the effort to develop and maintain the site so that customers can view the prints as they would appear either un- framed or framed and matted. A discussion with the IT professionals suggests that the time spent develop ing and maintaining the site for the unframed prints is considerably less than that required for the framed prints and in particular for the framed and matted prints. Developing and maintaining a site that can display the unframed prints is relatively straightforward. It becomes more complicated when the site must allow the customer to view every possible combination of print with every type of steel frame, and immensely more complicated when one considers all of the possible wood frames and different matting colors. Obviously, a very substantial portion of the IT professionals time and resources is required to present the over 1,000 different framing and matting options. Based on your preliminary findings, you have decided that the company's ability to measure and evaluate the profitability of individual products would be improved if the company employed an activity-based costing (ABC) system. As a first step in this effort, you compiled a list of costs, activities, and values. Your work consisted of taking the original manufacturing overhead cost (5375,200, provided in Case 1) and allocating the costs to activities. You identified four activities: picking prints inventory selection and management (includes general management and overhead); website optimization; and framing and matting cost (includes equipment, insurance, rent, and supervisor's salary) The first activity is picking prints. The estimated overhead related to this activity is $30,600. The cost driver for this activity is the number of prints. It is expected that the total number of prints will be 102,000. This is the sum of 80,000 unframed, 15,000 steel-framed, and 7,000 wood-framed
