Northpack, Inc.

Northpack, Inc., has recently expanded its line of backpacks to include high-quality, lightweight hiker backpacks. This

new model uses more expensive material and takes longer to produce. While a basic school backpack can be cut and

sewn together in 30 minutes, a hiker backpack takes 45 minutes to cut and sew together. The school model is

produced in batches of 1,000 packs, while the hiker model is produced in batches of 100 packs. Each batch of the

school model requires 1 hours of inspection time, and each batch of the hiker model requires 2 hours of inspection

time. Using direct labor hours to allocate manufacturing support costs (which in this company include ordering and

packaging costs), product profitability is analyzed as follows:

ITEM SCHOOL BACKPACKS HIKER BACKPACKS

Sales $15.00 $30.00

Less :

Direct materials 3.00 10.00

Direct labor 5.00 7.50

Manufacturing support 4.00 6.00

Gross margin $3.00 $6.50

Selling and administrative 1.00 2.00

Profit $2.00 $4.50

Sales volume 90,000 6,000

Jens Schmit, the controller at Northpack, believes that activity-based costing may be a more accurate way of

measuring the costs of the two models. He has traced manufacturing support costs to the following activity pools and

determined the practical capacity levels of the associated activity drivers :

COST DRIVER UNITS DEMANDED

ACTIVITY ACTIVITY COSTS ACTIVITY DRIVER SCHOOL MODEL HIKER MODEL

Cutting machines $52,000 Machine hours 9,000 1,125

Sewing machines 163,300 Direct labor hours 45,000 4,500

Packaging - order related 8,300 Number of orders 450 200

Packaging - volume related 150,000 Number of items packed 90,000 6,000

Orders 14,000 Number of orders 450 200

Inspections ? Hours of inspections ? ?

Total $?

Selling and administrative expenses are fixed business-sustaining costs.

Customers pay actual shipping charges, which are not included in these figures.

a. The method of assigning costs to individual products does not affect the total manufacturing support costs. Only

the amounts assigned to individual products change. Explain why Jens should care about how support costs are

assigned to individual products.

b. Using activity-based costing, calculate the cost per unit for each of the two models and analyze their profitability.

c. How might managers use the activity-based costing information to enhance the company's profitability? Consider

pricing changes and process changes among your suggestions.

d. Suppose that practical capacity remains as described earlier but that demand for the school model is only 85,000

units, while demand for the hiker model remains at 6,000 units. For the school model, the cutting machine hours

are now 8,500 and the number of orders is 425. Calculate the cost per unit for each of the two models andan income statement also showing the cost of unused capacity for each activity should be prepared. What actions mightmanagement take to deal with the unused capacity highlighted in your analysis?