Part 1- 15 Points

Marcia Brady is the relatively new controller of the Hair Care Division of Nova Scotia Body and Health (NSBH). She completed his CPA designation three years earlier and has worked at the Hair Care Division for the past six months.

The Hair Care Division (HCD) is located in Halifax, which is also the headquarters of NSBH. This location gives NSBH excellent access to distribution networks across North America while enjoying very low operating costs. (Wages and occupancy costs in Halifax are 4060% lower than metropolitan centres like Vancouver or Toronto.)

At the request of the divisions long-time president, Elizabeth MacDonald, HCD developed a proposal for a new product to be called Vital Hair. This product is a cream to be rubbed on the scalp to restore hair growth. The fixed costs associated with the development, production, and marketing of Vital Hair are $25,000,000. The majority of these costs are associated with the human trials needed to get federal health approval for this type of product. Due to the nature of the product, it has to be monitored by a doctor.

Each customer will pay a doctor $98 per monthly treatment, of which $68 is paid to NSBH. Brady estimates NSBHs variable costs per treatment to be $28.50. Included in this is $9.25 for potential product litigation costs. Brady did some research on this type of product, and while most of the data came from the United States, she noticed that there is an increasing trend in Canada for consumers to take companies to court for the slightest issue with a product.

Elizabeth MacDonald and Brady are scheduled to make a presentation to the NSBH executive committee on the expected profitability of Vital Hair. After reading Bradys report, MacDonald called her to her office. MacDonald was livid at Brady for including the $9.25 estimate. She argued that it is imperative to get the R&D funds approved (and quickly) and that any number that increases the breakeven point reduces the likelihood of the Vital Hair project being approved. She notes that NSBH has had few successful lawsuits against it, in contrast to some recent horrendous experiences of competitors with breast implant products. Moreover, she was furious that Brady put the $9.25 amount in writing. How do we know there will be any litigation problem? She suggested that Brady redo the report excluding the $9.25 litigation risk cost estimate. Put it on the whiteboard in the executive committee room, if you insist, but dont put it in the report sent to the committee before the meeting. You can personally raise the issue at the executive committee meeting and have a full and frank discussion.

Brady took MacDonalds advice. She changed the reports variable cost to $19.25 per treatment. Although she felt uneasy about the changes, she was comforted by the fact that she would flag the $9.25 amount to the executive committee in his forthcoming oral presentation.

One month later, MacDonald walked into Bradys office. She is in a buoyant mood and announces she has just come back from an executive committee meeting that approved the Vital Hair proposal. Brady asks why she was not invited to the meeting. MacDonald says the meeting was held in Toronto, and she decided to save the division money by going alone. She then says to Brady, It is now time to get behind the new venture and help make it the success the committee and the team members believe it will be.

Required

1. What is the breakeven point (in units of monthly treatments) when NSBHs variable costs (a) include the $9.25 estimate and (b) exclude the $9.25 estimate for potential product litigation costs?
2. Should Brady have excluded the $9.25 estimate in her report to the executive committee of NSBH? Explain your answer.
3. What should Brady do in response to MacDonalds decision to make the presentation on her own? What options does she have? As a CPA what are his responsibilities?

2.SMU Wheels Corporation manufactures two productsTricycles and Wagons. The annual production and sales of Tricycles is 2,000 units, while 1,500 units of Wagons are produced and sold. The company has traditionally used direct labour hours to allocate its overhead to products. Tricycles require 1.5 direct labour hours per unit, while Wagons require 3.0 direct labour hours per unit. The total estimated overhead for the period is $215,000. The company is looking at the possibility of changing to an activity-based costing system for its products. If the company used an activity-based costing system, it would have the following three activity cost pools:

1. Calculate the overhead per unit for a Wagon using the traditional system based on a single overhead rate (use direct labour hours as the cost driver).
2. Calculate the overhead per unit for a Wagon using the activity-based costing system.

Expected activity Tricycles Wagons 25 75 Activity cost pool Setup costs Engineering costs Maintenance costs Total Estimated overhead cost $ 50,000 $ 7,500 $ 157,500 $ 215,000 Total 100 100 4,500 60 3,000 40 1,500