Ripken Products: A Case for Learning Activity-Based Costing (ABC) Learning Objectives: This case enables students to learn the following points: Traditional absorption costing can trigger dysfunctional decisions. ABC is a costing system that assigns costs to products (or other cost objects) based on traceable consumption of resources. ABC provides new insights regarding product costs and product profitability. ABC cost assignment is an improvement on traditional costing that arbitrarily allocates overhead costs to products. ABC challenges conventional wisdom that manufacturing overhead costs are always indirect costs. They will learn methods of calculating ABC costs. CASE SCENARIO: RIPKEN PRODUCTS For years, I have been telling you that your cost accounting system is broken. I have had it with your numbers, Ed. I never trusted them. You will be sorry that you made this decision, Paul. Now I must get back to my people on the plant floor. With these words, Production V.P., Rick Dempsey stormed out of the weekly Thursday meeting of the Ripken Products senior management team. At the meeting, owner and CEO Paul Richards announced the decision to eliminate the Delete product from the companys product line. Since its founding six years earlier, Ripken Products manufactured all of its four products in its Towson, Maryland plant. After assessing profitability of each product based upon the analysis prepared by company controller, Ed Murray, Richards decided to eliminate its Delete product two days earlier. He announced his decision at the meeting with the companys five senior managers: Ed Murray, Controller Rick Dempsey, VP of Production L. Rod Hendricks, VP of Marketing Jim Palmer, VP of Human Resources Ruth George, Sales Manager Page 1 of 5

Ripken Products produces four chemical eradicators: Abolish, Banish, Cancel, and Delete. Within the company, they are referred to as products A, B, C, & D. The company uses normal absorption costing to account for its manufacturing costs. Ripkens costing system charges manufacturing overhead costs to these products using direct labor dollars as an allocation base. The companys 2022 manufacturing budget included the following amounts: direct material costs of $900,000 direct labor costs of $840,000 manufacturing overhead of $1,680,000 Based upon its estimated 2022 manufacturing costs, the companys budgeted manufacturing overhead rate for 2022 was $2.00 of manufacturing overhead per $1.00 of direct labor, (or simply 2.00) as calculated below. Budgeted Mfg. Overhead Rate = Estimated Manufacturing Overhead for 2022 = $1,680,000 = 2.00 Estimated Direct Labor Cost for 2022 $840,000 Table 1 presents the companys 2022 budgeted manufacturing costs, by product and in total. To allocate the total budgeted manufacturing overhead of $1,680,000 to individual products, the direct labor cost for each product is multiplied by 2.00. Table 1: 2022 Estimated Manufacturing Costs (using absorption costing) A B C D Total Direct Material Cost Direct Labor Cost Manufacturing Overhead Total Manufacturing Cost Units Produced Cost per Unit $90,000 84,000 168,000 $342,000 342,000 $1.00/unit $90,000 84,000 168,000 $342,000 342,000 $1.00/unit $180,000 168,000 336,000 $684,000 684,000 $1.00/unit $540,000 504,000 1,008,000 $2,052,000 684,000 $3.00/unit $900,000 840,000 1,680,000 $3,420,000 The companys 2022 pro forma income statement is presented in Table 2. There was no inventory on December 31, 2021 and it plans to have no inventory of any product on December 31, 2022. Table 2: 2022 Pro Forma Income Statement A B C D Total Sales Cost of Goods Sold Gross Profit Operating Expenses Profit Before Taxes $410,400 342,000 $68,400 $376,200 342,000 $34,200 $957,600 684,000 $273,600 $2,052,000 2,052,000 0 $3,796,200 3,420,000 $376,200 320,000 $56,200 Page 2 of 5

Because of constraints on the AB-19 machine, the company can produce a total of 684,000 units of Abolish and Banish, in any combination. For example, the company can produce 683,000 Abolish units and 1,000 Banish units. Similarly, the CD-25 machine can produce a total of 1,368,000 Cancel and Delete units. Because of this and because the prices of all products are determined by the market, L. Rod Hendricks, Marketing VP, had been advocating for elimination of products Banish and Delete. In conversations with Controller Ed Murray over the years, Rick Dempsey had expressed his dissatisfaction with the timeliness, usefulness and accuracy of the Accounting Departments monthly manufacturing control reports. In recent months, Dempsey used almost no information in these reports to make decisions regarding managing production in the plant. In prior conversations, Murray explained that the monthly reports reflected traditional costing practices that were described in the three Cost Accounting text books that he gave to Dempsey in 2011. During several contentious debates, Murray reminded Dempsey that he was both a Certified Public Accountant (C.P.A.) and a Certified Management Accountant (C.M.A.). Upon returning to the production office, Dempsey discussed the details of the meeting with production supervisor, Paul Blair, and production student intern, Robin Brooks. Brooks told them of a discussion that she had two weeks earlier with Ed Murray. Brooks said that she suggested to Murray that basing product costs on activity- based cost drivers would result in more reliable cost data than that provided by the companys traditional costing system. She said that Murray showed little interest in this method, commonly referred to as activity-based costing (ABC), and the conversation ended abruptly when Murray asked to be excused. Rick Dempsey asked Robin Brooks to explain ABC to him, and Robin took the next hour to do so. At the end of the discussion, he asked her to calculate product costs for the four products using ABC. When she estimated that it would take her about two weeks to complete the assignment, Dempsey asked if they could work together to do the work within three days. She agreed to work overtime to try to meet the deadline. One day later, Robin Brooks presented Rick Dempsey with the information in Table 3. The table identifies the six manufacturing overhead categories and their associated costs. Together, they comprise total budgeted manufacturing overhead costs for 2022. Table 3: Estimated Manufacturing Overhead (2022) Purchasing Machine setups for production runs Material movements Machine depreciation Facility rent Other manufacturing overhead Total $72,000 92,500 36,000 840,000 480,000 159,500 $1,680,000 Working together over the next two days, Dempsey and Brooks compiled and organized the information in Tables 4 & 5 regarding the companys transactions and cost drivers: Page 3 of 5

Table 4: Transactions by Product (2022 Estimates) Activity POs Written # of production run setups Material movements Machine hours Work cell size in sq. feet A B 180 18 148 37 600 120 10,500 3,500 6,400 3,200 C D 126 36 74 111 360 120 28,000 28,000 16,000 6,400 Total 360 370 1,200 70,000 32,000 Table 5: Cost per Transaction Calculations (2022 Estimates) Overhead Cost Pool Total Cost Purchasing $72,000 Transactions / 360 = / 370 = / 1,200 = / 70,000 = / 32,000 = / 70,000 = Cost per Transaction Machine Setups Material Movements Machine Cost Facility Rent Other Manufacturing Overhead * 92,500 36,000 840,000 480,000 159,500 $ $ $ 200 per P.O. 250 per setup 30 per move 12 per mach. hr. 15 per square ft. $ $ $ 2.2786 per mach. hr. *Other Manufacturing Overhead represents various overhead costs for which the cost-per-transaction is too expensive to determine. Robin thought it best to allocate these costs (9.5% of total overhead) on a machine-hour basis. As they reviewed this information at 5:30 on Thursday evening, Dempsey and Brooks expressed their mutual concerns about the unit product costs in Table 2. Each felt that there were distortions in the companys unit production costs of $1.00 for A, B, and C, and $3.00 for D. They decided to work for another two hours in order to see if they could identify the ABC unit costs for these four products by using the information that they compiled over the last three days. Dempsey and Brooks decided to assign manufacturing overhead to products based upon the activities that cause those overhead costs. They began by erasing the overhead allocations in Table 1, because they were made without consideration of the activities that cause these costs. They made no changes to direct materials and direct labor costs, because these direct costs are the same for either traditional costing or ABC. They realized that assigning manufacturing overhead in Table 6, based on the calculations in Tables 3, 4, & 5, would leave them with only simple calculations to determine ABC Cost per unit amounts for each product. They continued their work with a feeling of anticipation, wondering whether their suspicions of significant costing distortions would be substantiated. Page 4 of 5

Realizing that they had to redistribute the $1,680,000 of total manufacturing overhead cost to the four products, Dempsey and Brooks put aside Table 6 until they were able to reassign these costs. Table 6: 2022 Estimated Manufacturing Costs (using Activity-based Costing [ABC]) A B C D Total Direct Material Cost Direct Labor Cost Manufacturing Overhead Total Manufacturing Cost Units Produced Total Mfg. Cost per Unit $90,000 84,000 342,000 $90,000 84,000 342,000 $180,000 168,000 684,000 $540,000 504,000 684,000 $900,000 840,000 1,680,000 $3,420,000 Robin handed a copy of Table 7 to Rick Dempsey and kept a copy for herself. They agreed that he would assign the costs for purchasing, machine setups, and material movements, and that she would do the same for the other three cost pools. They were enthusiastic regarding this endeavor. Table 7: Manufacturing Overhead Cost Assignment for 2022 (Using ABC) Overhead Cost Pool Cost per Activity Purchasing 200 Machine Setups 250 Material Movements 30 Machine Cost 12 Facility Rent 15 Other Manuf. Overhead 2.2786 Total Manuf. Overhead A B C D Total $72,000 92,500 36,000 840,000 480,000 159,500 $1,680,000 Required: 1. Using Excel**, complete Table 7 to determine total manufacturing overhead by product using ABC. (7 marks) 2. Using Excel**, complete Table 6 to determine total manufacturing cost by product using ABC. (6 marks) 3. a) Using Excel**, prepare 2022 Pro Forma Income Statement (using ABC) (i.e. similar to the format of Table 2). (5 marks) b) Identify which products are profitable and which products are not profitable if the company uses ABC. (2 marks) ** Make sure to use formulas in excel and not just to enter numbers.