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Dunes and Stars Company is a manufacturer of tents and camping accessories. The company's plant manufactures three product lines, each producing a tent brand. These

Dunes and Stars Company is a manufacturer of tents and camping accessories. The company's plant manufactures three product lines, each producing a tent brand. These brands are Model (1), Model (2), and Model (3). Until recently,the company's plant used a job-order product-costing system. The cost of each product was the sum of its actual direct-material cost, actual direct-labour cost, and applied manufacturing overhead as follows:

Exhibit (1)

Products

Cost items

Model (1) Model (2) Model (3)
Planned annual production 15,000 12,000 3,000
Raw material cost per unit $200 $240 $360
Labour wage rate per hour $20 $20 $20
Labour hours required per unit 9 hours 11 hours 13 hours

Overhead was applied using a predetermined overhead rate based on direct labour hours. Using the traditional system, all of theDunes and Starsplant's budgeted manufacturing overhead costs are lumped together in a single cost pool.

Trouble inDunes and Stars Company

The profitability ofDunes and Stars Company operation has been faltering in recent years. The company's pricing policy has set a target price for each tent equal to 120% of the total product cost. However, the actual prices of these products are different when compared to volume-costing system-based targeted prices, as shown in the following table:

Exhibit (2)

Product price Model (1) Model (2) Model (3)
Actual selling price $1,199.99 $1,399.99 $1,599.99

Due to price competition from other Tent manufacturers, Model (1) Tents were sold at lower prices than the target. Moreover,Dunes and Stars Company's competition forced management to reduce the price of Model (2) Tent. Even at this lower price, the sales team had difficulty getting orders for its planned volume of Model (2) Tent production. Fortunately, the disappointing profitability of Model (1) and Model (2) Tents were partially offset by greater-than-expected profits on the Model (3) line of Tents.Dunes and Stars Company's sales personnel had discovered that the company was swamped with orders when Model (3)'s price was determined.

Consequently, management raised the price of Model (3) Tent several times, eventually raising the product's price. Even at this price,Dunes and Stars Company's customers did not hesitate to place orders. Moreover, the company's competitors did not mount a challenge in Model (3) line of Tents market.Dunes and Stars Company's management was pleased to have a niche for Model (3) Tent market, which appeared to be a highly profitable, low-volume speciality product. Nevertheless, concern continued to mount inDunes and Starsabout the difficulty in the company's Model (1) and Model (2) Tent markets. After all, these were theDunes and Stars plant's bread-and-butter products, with projected annual sales of 15,000 Model (1) Tents, 12,000 Model (2) Tents and 3,000 Model (3) Tents.

New costing system and data collection

Dunes and Stars Company's director of cost management, Hamilton Burger, had been thinking for some time about refining theDunes and Stars plant's product-costing system. He wondered if the traditional, volume-based system provided management with accurate data about product costs. Burger had read about Activity-based Costing (ABC) systems, which follow a two-stage procedure to assign product overhead costs.

Dunes and Stars Company had formed a team to collect data for the ABC system. In the first stage, the team identified significant activities in producing the three products and assigned overhead costs to each activity based on the cost of the organization's resources of activity cost pools. In stage two of the activity-based costing project, the team identified cost drivers for each activity cost pool that have been used forDunes and Stars Company's three product lines, as shown in the following exhibit:

Exhibit (3)

Activity Activity Driver Activity Cost Pool Product lines
Model (1) Model (2) Model (3)
Machinery Machine hours 1,860,000 100,000 97,500 35,000
Set-up Production runs 2,100,000 80 80 40
Purchasing Purchase orders 3,000,000 200 192 208
Material-Handling Production runs 3,400,000 80 80 40
Quality-Assurance Inspection hours 1,100,000 800 800 600
Packing/Shipping Shipments 2,640,000 1,000 800 400
Engineering Design Engineering hours 1,300,000 500 400 400
Facility Machine hours 2,300,000 100,000 96,000 34,000

ABC-based customer profitability analysis

TWO more years have passed, and the company has successfully implemented its activity-based costing system in itsDunes and Stars plant, at a recent strategy meeting with her senior company management team,Dunes and Stars Company's president and CEO expressed interest in assessing the profitability of the company's various customer relationships. He found support for the idea from the director of cost management, who had been reading about customer-profitability analysis in some of his professional journals. The company's marketing manager also expressed interest in customer-profitability analysis since he is concerned about the profitability of a couple ofDunes and Stars Company's customers. "We have a few customers who seem to want the moon and the stars when it comes to customer service," he complained. "I know the customer is always right, but you have to wonder if we are making any money from a couple of these customers, what with all the extra design and packaging they demand. Moreover, some customers require extra attention to sales calls, order processing, and billing. If we had a better idea of each customer's profitability, it would help our marketing and sales staff to focus their efforts."

The controller soon had his cost management staff attacking the customer-profitability analysis that the president had requested. The first step required an activity-based costing analysis of certain customer-related costs that could seriously affect a customer's profitability. Recall that ABC analysis relies on a cost hierarchy with cost levels, such as unit-level, batch-level, product-line-level, customer-level, and facility or general operations-level costs. In using activity-based costing, the cost management team focuses on customer-related costs. After extensive analysis and several interviews with personnel throughoutDunes and Stars Company, the cost management team came up with the ABC analysis in the following table:

Based on the activity-based costing information, the cost management team assessed the profitability of each ofDunes and Stars Company's customer relationships. Detailed information from that analysis for five of these customers appears in the following table:

Exhibit (4)

Tents Lines Total sold units Customer 1 Customer 2 Customer 3 Customer 4 Customer 5
Sold Units of tents Model (1) 15,000 4,500 10,500 0 0 0
Model (2) 12,000 4,000 1,500 5,000 1,500 0
Model (3) 3,000 0 0 0 1,500 1,500
Total 30,000 8,500 12,000 5,000 1,500 1,500

Exhibit (5)

Selling andadministrative costs: Cost driver base Cost pool Customer 1 Customer 2 Customer 3 Customer 4 Customer 5
Generaladministrative costs Orders $1,000,000 34 35 57 448 456

Customer related costs

(Selling costs)

Order processing Orders 168,000 34 35 57 448 456
Sales contracts Contracts 120,300 10 24 35 241 388
Sales visits Visits 201,000 44 20 47 58 32
Shipment processing Shipments 188,800 165 139 220 223 96
Billing and collection Invoices 160,000 110 88 120 240 260
Design engineering changes Design engineering changes 850,000 30 40 50 280 370
Special packaging Units packaged 300,840 200 683 850 1,110 1,920
Special handling Units handled 181,840 4,500 6,000 3,500 4,000 2,000
Total customer-related costs (selling costs) 2,170,780
Total selling andadministrative costs 3,170,780

  1. Determine (a) product cost, (b) selling price, and (c) product profitability for Model (1), Model (2) and Model (3) using volume-based costing systems.
  2. Determine (a) product cost, (b) selling price, and (c) product profitability for Model (1), Model (2) and Model (3) using activity-based costing systems.
  3. estimated product cost calculated in (1), determine the profitability of five customers using volume-based costing systems.
  4. estimated product cost calculated in (2), determine the profitability of five customers using activity-based costing systems.

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