Holly Manufacturing Case

Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods. The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more experienced workers who are paid at a higher rate.

Most of Hollys sales come from the standard cello, but sales of the custom model have been growing. Following is the companys sales, production, and cost information for last year:

Cello		Standard	Custom
Sales and production volume in units		900	100
Unit Selling Price		$600.00	$900.00
Unit costs:
Direct materials		$150.00	$375.00
Direct labor		$180.00	$240.00
Manufacturing overhead*		$135.00	$135.00
Total unit costs		$465.00	$750.00
Unit Gross Profit		$135.00	$150.00
Direct Labor Hours		10.00	10.00
Direct Labor Rate Per Hour		$18.00	$24.00

*Manufacturing overhead costs:
Building depreciation	$ 40,000
Maintenance	15,000.00
Purchasing	20,000.00
Inspection	12,000.00
Indirect materials	15,000.00
Supervision	30,000.00
Supplies	3,000.00
Total manufacturing overhead costs		$135,000.00

These manufacturing overhead costs are fixed in nature: they do not vary with the volume of manufacturing activity.

The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate, based on 10,000 direct labor hours, is $13.50 ($135,000 10,000 direct labor hours). Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate information and that the selling price of the custom cello may not be covering its true cost.

1. What should Holly Manufacturing do about this situation?

2. What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?

3. What should Holly Manufacturing do about the situation if the price of custom cello cannot exceed $900?