I have attached word document with question - cost accounting.

CableTech Bell Corporation (CTB) operates in the telecommunications industry. CTB has two divisions: the Phone Division and the Cable Service Division. The Phone Division manufactures telephones in several plants located in the Midwest. The product lines run from relatively inexpensive touch-tone wall and desk phones to expensive, high-quality cellular phones. CTB also operates a cable TV service in Ohio. The Cable Service Division offers three products: a basic package with 25 channels; an enhanced package, which is the basic package plus 15 additional channels and two movie channels; and a premium package, which is the basic package plus 25 additional channels and three movie channels. The Cable Service Division reported the following activity for the month of March: Basic Enhanced Premium 50,000 500,000 300,000 $16 $30 $40 Directly traced $3 $5 $7 Driver traced $2 $4 $6 $10 $13 $15 Sales (units) Price per unit Unit costs: Allocated The unit costs are divided as follows: 70 percent production and 30 percent marketing and customer service. Direct labor cost is the only driver used for tracing. Typically, the division uses only production costs to define unit costs. The preceding unit product cost information was provided at the request of the marketing manager and was the result of a special study. Bryce Youngers, the president of CTB, is reasonably satisfied with the performance of the Cable Service Division. March's performance is fairly typical of what has been happening over the past two years. The Phone Division, however, is another matter. Its overall profit performance has been declining. Two years ago, income before income taxes had been about 25 percent of sales. March's dismal performance was also typical for what has been happening this year and is expected to continue unless some action by management is taken to reverse the trend. During March, the Phone Division reported the following results: Inventories: Materials, March 1 Materials, March 31 Work in process, March 1 Work in process, March 31 Finished goods, March 1 $23,000 40,000 130,000 45,000 480,000 Finished goods, March 31 375,000 Costs: Direct labor $117,000 Plant and equipment depreciation 50,000 Materials handling 85,000 Inspections 60,000 Scheduling 30,000 Power 30,000 Plant supervision 12,000 Manufacturing engineering 21,000 Sales commissions 120,000 Salary, sales supervisor 10,000 Supplies 17,000 Warranty work 40,000 Rework 30,000 During March, the Phone Division purchased materials totaling $312,000. There are no significant inventories of supplies (beginning or ending). Supplies are accounted for separately from materials. CTB's Phone Division had sales totaling $1,170,000 for March. Based on March's results, Bryce decided to meet with three of the Phone Division's managers: Kim Breashears, divisional manager; Jacob Carder, divisional controller; and Larry Hartley, sales manager. A transcript of their recorded conversation is given next: Bryce: \"March's profit performance is down once again, and I think we need to see if we can identify the problem and correct itbefore it's too late. Kim, what's your assessment of the situation?\" Kim: \"Foreign competition is eating us alive. They are coming in with lower-priced phones of comparable or higher quality than our own. I've talked with several of the retailers that carry our lines, and they say the same. They are convinced that we can sell more if we lower our prices.\" Larry: \"They're right. If we could lower our prices by 10 to 15 percent, I think that we'd regainmost of our lost market share. But we also need tomake sure that the quality of our products meets that of our competitors. As you know, we are spending a lot of money each month on rework and warranties. That worriesme. I'd like to see that warranty cost cut by 70 to 80 percent. If we could do that, then customers would bemore satisfied with our products, and I bet that we would not only regain our market share but increase it.\" Jacob: \"Lowering prices without lowering per-unit costs will not help us increase our profitability. I think we need to improve our cost accounting system. I am not confident that we really know how much each of our product lines is costing us. It may be that we are overpricing some of our units because we are overcosting them. We may be underpricing other units.\" Larry: \"This sounds promisingespecially if the overcosting is for some of our high-volume lines. A price decrease for these products would make the biggest differenceand if we knew they were overcosted, then we could offer immediate price reductions.\" Bryce: \"Jacob, I need more explanation. We have been using the same cost accounting system for the last 10 years. Why would it be a problem?\" Jacob: \"I think that our manufacturing environment has changed. Over the years, we have added a lot of different product lines. Some of these products make very different demands on our manufacturing overhead resources. We traceor attempt to traceoverhead costs to the different products using direct labor cost, a unit-based cost driver. We may be doing more allocation than tracing. If so, then we probably don't have a very good idea of our actual product costs. Also, as you know, with the way computer technology has changed over time, it is easier and cheaper to collect and use detailed information information that will allow us to assign costs more accurately.\" Bryce: \"This may be something we should explore. Jacob, what do you suggest?\" Jacob: \"If we want more accurate product costs and if we really want to get in the cost reduction business, then we need to understand how costs behave. In particular, we need to understand activity cost behavior. Knowing what activities we perform, why we perform them, and how well we perform them will help us identify areas for improvement. We also need to know how the different products consume activity resources. What this boils down to is the need to use an activity-based management system. But before we jump into this, we need some idea of whether non-unit-based drivers add anything. Activity-based management is not an inexpensive undertaking. So I suggest that we do a preliminary study to see if direct labor cost is adequate for tracing. If not, then maybe some non-unitdrivers might be needed. In fact, if you would like, I can gather some data that will provide some evidence on the usefulness of the activity-based approach.\" Bryce: \"What do you think, Kim? It's your division.\" Kim: \"What Jacob has said sounds promising. I think he should pursue it and do so quickly. I also think that we need to look at improving our quality. It sounds like we have a problem there. If quality could be improved, then our costs will drop. I'll talk to our quality people. Jacob, in the meantime, find out for us if moving to an activity-based system is the way to go. How much time do you need?\" Jacob: \"I have already been gathering data. I could probably have a report within two weeks.\" MEMO TO: Kim Breashears FROM: Jacob Carder SUBJECT: Preliminary Analysis Based on my initial analysis, I am confident that an ABC system will offer significant improvement. For one of our conventional phone plants, I regressed total monthly overhead cost on monthly direct labor cost using the following 15 months of data: Overhead Direct Labor Cost $360,000 $110,000 300,000 100,000 350,000 90,000 400,000 100,000 320,000 90,000 380,000 100,000 300,000 90,000 280,000 90,000 340,000 95,000 410,000 115,000 375,000 100,000 360,000 85,000 340,000 85,000 330,000 90,000 300,000 80,000 The results were revealing. Although direct labor cost appears to be a driver of overhead cost, it really doesn't explain a lot of the variation. I then searched for other driversparticularly non-unit drivers that might offer more insight into overhead cost behavior. Every time a batch is produced, material movement occurs, regardless of the size of the batch. The number of moves seemed like a more logical driver. I was able to gather only 10 months of data for this. (Our information system doesn't provide the number of moves, so I had to build the data set by interviewing production personnel.) This information is provided next: Materials-Handling Cost $80,000 Number of Moves 1,500 60,000 1,000 70,000 1,250 72,000 1,300 65,000 1,100 85,000 1,700 67,000 1,200 73,500 1,350 83,000 1,400 84,000 1,700 The regression results were impressive. There is no question in my mind that the number of moves is a good driver of materials-handling costs. Using the number of moves to assign materials-handling costs to products would likely be better than the cost assignment using direct labor cost. Furthermore, since small batches use the same number of moves as large batches, we have some evidence that we may be overcosting our high-volume products. I looked at one more overhead activity: inspecting products. We have 15 inspectors who are paid an average of $4,000 per month. Each inspector offers about 160 hours of inspection capacity per month. However, it appears that they actually work only about 80 percent of those hours. The drop in demand we have experienced explains this idle time. I see no evidence of variable cost behavior here. I'm not exactly sure how to treat inspection cost, but I think that it is more related to inspection hours than direct labor cost. Some of the other overhead activities seem to be non-unit-level, as well enough, in fact, to be concerned about how we assign costs. After receiving the memo, Kim was intrigued. She then asked Jacob to use the same phone plant as a pilot for a preliminary ABC analysis. She instructed him to assign all overhead costs to the plant's two products (Regular and Deluxe models), using only four activities. The four activities were rework, moving materials, inspecting products, and a general catch-all activity labeled \"other manufacturing activities.\" From the special study already performed, she knew that materials handling and inspecting involved significant cost; from production reports, she also knew that the rework activity involved significant cost. If the ABC and unit-based cost assignments did not differ by breaking out these three major activities, then ABC may not matter. Pursuant to the request, Jacob produced the following cost and driver information: Activity Expected Cost Driver Activity Capacity Other activities $2,000,000 Direct labor dollars $1,250,000 Moving materials 900,000 Number of moves 18,000 Inspecting 720,000 Inspection hours 24,000 Reworking 380,000 Rework hours Total overhead cost 3,800 $4,000,000 Expected activity demands: Regular Model Units completed Deluxe Model 100,000 40,000 $875,000 $375,000 Number of moves 7,200 10,800 Inspection hours 6,000 18,000 Rework hours 1,900 1,900 Direct labor dollars Required: 1. Compute two different unit costs for each of the Cable Service Division's products. What managerial objectives are being served by these unit cost computations? Round the answers to two decimal places. Basic Method I Enhanced $ Premium $ $ Method II Method I costs include all production, marketing, and customer service costs. There may be, and very likely is, very little R&D function in the Cable Service Division. Thus, this first unit cost could satisfy both value-chain and operating cost definitions. The objectives include pricing decisions, product mix decisions, and strategic and tactical profitability analysis. Method I costs include only production costs; complying with external financial reporting guidelines is the primary managerial objective of this method. 2. Three different cost categories are provided by the Cable Service Division: direct tracing, driver tracing, and allocation. Discuss the meaning of each. Based on how costs are assigned, do you think that the Cable Service Division is using a functional-based or an activity-based cost accounting system? What other differences exist between functional-based and activity-based cost accounting systems? Direct tracing is a cost assignment method that relies on physically observable causal relationships to assign costs to cost objects. Driver tracing relies on causal factors called drivers to assign costs to cost objects. Allocation relies on assumed linkages or convenience (ease of use) to assign cost to cost objects. The cost assignment approach used by the Cable Service Division appears to beallocation . No non-unit-level drivers are being used to assign costs. Apparently, the usual and only product cost definition provided by the accounting system is based on production costs. Other variants such as the one provided are obtained only by special efforts. This provides evidence that the division is using a functional-based cost accounting system. Other differences that distinguish the two systems (but are not mentioned) are the presence or absence of detailed activity information, whether activities or costs are the focus, whether the emphasis is on local or system wide performance measurement, and the use (or nonuse) of nonfinancial performance measures. 3. Discuss the differences between the Cable Service Division's products and the Phone Division's products. The two divisions differ based on the nature of their output Telephones are tangible products, and cable services are intangible products. Tangible products are produced by converting materials through the use of labor and other inputs such as plant, land, and machinery. Services are tasks or activities performed for a customer or an activity performed by a customer using an organization's products or facilities. Cable service differs from telephones in that cable services are intangible and perishable (cannot be inventoried). Phones can be felt, seen, and stored. Cable services cannot. 4. Prepare an income statement for the Cable Service Division for March. Cable Service Division Income Statement For the Month of March $ Sales revenue Cost of services sold Gross margin $ Less: Operatin g expense s Income $ before income taxes Feedback Correct 5a. Prepare the cost of goods manufactured statement for the Phone Division for March. Phone Division Statement of Cost of Goods Manufactured For the Month of March Direct materials: Beginning $ inventory Add: Purchases Materials available $ Direct materials used $ Direct labor Overhead: $ Total manufacturing costs added: Cost of goods manufactur ed $ $ Feedback Partially correct 5b. Prepare an income statement for the Phone Division for March. Phone Division Income Statement For the Month of March $ Cost of goods sold: $ Goods availabl $ e for sale $ $ Feedback Incorrect 6. The Phone Division has been using the same cost accounting system for over 10 years. Explain why its cost accounting system may be outmoded. What factors determine when a new cost accounting system is warranted? The Phone Division has added a number of different products over the years. The different products seem to consume overhead resources in different proportions. There is some belief that using only unit-based drivers is inadequate for assigning overhead costs. Furthermore, 10 years have passed since the current cost accounting system was adopted, information processing technology has advanced, and it is cheaper to operate more sophisticated cost accounting systems. Also, if the current system is overcosting the high-volume products as suggested, then bad pricing decisions are being made that could be very costly for the companyespecially considering the increased competition. Decreased measurement costs and increased error costs are the major factors signaling the obsolescence of the current system and the need for a new system. For CTB, measurement costs have likely decreased. Evidence indicates that there may be bad cost assignments, and the cost of bad decisions has gone up. Taken together, a new system seems justified. 7. Using the method of least squares, calculate two cost formulas: one for overhead using direct labor cost as the driver, and one for materials handling cost using number of moves as the driver. Round the intercept to the nearest dollar and round the slope to the nearest cent. Formula one, overhead and direct labor cost: Y=$ +$ X Formula two, materials handling cost and number of moves: Y=$ +$ X Comment on Jacob Carder's observations concerning the outcomes. Jacob's comments seem to be on target. Direct labor cost explains less than 40 percent of the variability in overhead costnot enough to justify using Direct labor cost as the only driver to trace overhead to individual products. The number of moves a non-unit driver, explains 90 percent of the materials-handling cost variability. Using the number of moves to assign materials-handling cost appears reasonable and certainly better than using direct labor cost to assign this cost. In fact, since small batches use the same moves as large batches but much less labor, then large batches are receiving too much materials-handling cost. Thus, some evidence exists that high-volume products are overcosted . 8. How would you describe the cost behavior of the inspection activity? Assume that the quality control manager implements a program that reduces the number of defective units by 50 percent. Because of the improved quality, the demand for inspection hours will also drop by 50 percent. What is the potential monthly reduction in inspection costs? How did knowledge of inspection's cost behavior help? Inspection activity follows a step-cost function, with each step being defined by hours per year. Each step costs $ . Current total activity capacity is hours. Current demand for the activity is be hours. If the demand drops by 50 percent, then the new demand would hours. Unused capacity at this point will be hours. Thus, $ can be saved per month. 9. Calulate the overhead cost per unit for each phone model using direct labor cost to assign all overhead costs to products. Overhead Cost per Unit $ Regular $ Deluxe 10. Calculate the overhead cost per unit using the four activities and drivers identified by Kim and Jacob. If you were Kim, would you be inclined to implement an ABC system based on the evidence from this pilot test? If required, round the answers to two decimal place. Activity Rates Other: per direct labor dollar $ Moving: Inspecting: Reworking: $ $ per move per inspection hour per rework hour Unit Cost $ Regular $ Deluxe The cost per unit is much different based on the ABC assignments suggesting that improved accuracy can make a significant difference in managerial decision making. The evidence is supportive of implementing ABC. 11. Suppose someone urged Kim to look into Time-Driven Activity-Based Costing (TDABC) instead of 1. 2. 3. 4. ABC. What would be the advantages of using a TDABC aproach? Simple to implement Easy to update and maintain Ability to use time equations that easily capture what are essentially multiple activities It is possible to have a more granular model without the associated expense. All of the above