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Question 2 (30 minutes, 19 marks + 2 marks bonus) Mirabel Co. For many years Mirabel Company only manufactured and sold a regular model. However, the company saw an opportunity in the marketplace and decided to begin manufacturing and selling a customized model. Sales of the regular model have held steady at 10,000 units per year over the last five years whereas sales of the customized product have approximately doubled each year. Last year, sales of the customized model were 500 units. However, despite the fact total sales have been increasing, the company's overall gross margin has been shrinking. The President attributed this to the fact that the gross margin for the regular product has shrunk considerably from what it was five years ago. Upon viewing the latest financial reports, the president of Mirabel exclaimed: Thank god we introduced the customized product when we did. We'd be losing our shirt if we hadn't. We better start emphasizing the customized product more and de- emphasizing sales of the regular product. As a newly hired manager in the company, you pond this situation and thought you should do an investigation based on an ABC analysis something you learned in MGT 2400. You determine that total manufacturing overhead is a significant component of total product cost and has been growing over the years. The company currently allocates manufacturing overhead on the basis of machine hours. Finally, you believe that the overhead might be better allocated using three cost pools and have come up with the following information based on last year's situation: Last year's activity Regular Model Customized Model Sales = 10,000 units Sales = 500 units Total 12 Activity levels # of Production Setups # of Scrap/rework orders # Machine hours 500 100 1000 512 600 500 10,000 11,000 Approximate amount of Overhead allocated last year using the current approach: Regular $772,727 Customized 77,273 $850,000 Required: 1. Using the information provided above based on last year's information, calculate the activity- based cost driver rates for each of the three pools. Round your answers to two decimal points. (4.5 marks) 2. Determine the total amount of overhead that would have been allocated to each product (Regular and Customized) under ABC using last year's data. Round your answers to two decimal points. (6 marks) 3. Using the ABC information as the standard (i.e., the correct amount), determine the percentage amount that the present overhead allocation approach has over or under costed each product (1 mark) 4. Using the specifics of this company, explain to the President why the current approach to allocating overhead using machine hours has or has not led to a high level of cost distortion (6.5 marks) 5. Question to make you think. Based on your analysis above, the information contained in the first two paragraphs of the case, do you agree with the president's assessment that going forward the company should continue to emphasize the customized product more and de- emphasize sales of the regular product? Explain to the president why you think: a. the gross margin of the regular product has been shrinking (1 mark); and b. the company's overall gross margin has been shrinking even though sales have been increasing; (bonus 2 marks). You may want to consider answering parts 4 and 5 on your computer using Word if your handwriting is poor and then converting it to a PDF before submitting it in Crowdmark, Activity Cost Pool Production Setups Last year's Costs $200,000 Cost Driver # of setups # of scrap rework orders machine hours Scrap/rework Machine costs 400,000 250,000 $850,000 Question 2 (30 minutes, 19 marks + 2 marks bonus) Mirabel Co. For many years Mirabel Company only manufactured and sold a regular model. However, the company saw an opportunity in the marketplace and decided to begin manufacturing and selling a customized model. Sales of the regular model have held steady at 10,000 units per year over the last five years whereas sales of the customized product have approximately doubled each year. Last year, sales of the customized model were 500 units. However, despite the fact total sales have been increasing, the company's overall gross margin has been shrinking. The President attributed this to the fact that the gross margin for the regular product has shrunk considerably from what it was five years ago. Upon viewing the latest financial reports, the president of Mirabel exclaimed: Thank god we introduced the customized product when we did. We'd be losing our shirt if we hadn't. We better start emphasizing the customized product more and de- emphasizing sales of the regular product. As a newly hired manager in the company, you pond this situation and thought you should do an investigation based on an ABC analysis something you learned in MGT 2400. You determine that total manufacturing overhead is a significant component of total product cost and has been growing over the years. The company currently allocates manufacturing overhead on the basis of machine hours. Finally, you believe that the overhead might be better allocated using three cost pools and have come up with the following information based on last year's situation: Last year's activity Regular Model Customized Model Sales = 10,000 units Sales = 500 units Total 12 Activity levels # of Production Setups # of Scrap/rework orders # Machine hours 500 100 1000 512 600 500 10,000 11,000 Approximate amount of Overhead allocated last year using the current approach: Regular $772,727 Customized 77,273 $850,000 Required: 1. Using the information provided above based on last year's information, calculate the activity- based cost driver rates for each of the three pools. Round your answers to two decimal points. (4.5 marks) 2. Determine the total amount of overhead that would have been allocated to each product (Regular and Customized) under ABC using last year's data. Round your answers to two decimal points. (6 marks) 3. Using the ABC information as the standard (i.e., the correct amount), determine the percentage amount that the present overhead allocation approach has over or under costed each product (1 mark) 4. Using the specifics of this company, explain to the President why the current approach to allocating overhead using machine hours has or has not led to a high level of cost distortion (6.5 marks) 5. Question to make you think. Based on your analysis above, the information contained in the first two paragraphs of the case, do you agree with the president's assessment that going forward the company should continue to emphasize the customized product more and de- emphasize sales of the regular product? Explain to the president why you think: a. the gross margin of the regular product has been shrinking (1 mark); and b. the company's overall gross margin has been shrinking even though sales have been increasing; (bonus 2 marks). You may want to consider answering parts 4 and 5 on your computer using Word if your handwriting is poor and then converting it to a PDF before submitting it in Crowdmark, Activity Cost Pool Production Setups Last year's Costs $200,000 Cost Driver # of setups # of scrap rework orders machine hours Scrap/rework Machine costs 400,000 250,000 $850,000