This assignment is on the decision-making benefits of activity-based costing relative to the traditional approach. It also offers an opportunity to discuss the cost/benefit trade-off between simple ABC systems versus refined systems and the potential benefit of using capacity rather than expected sales when allocating fixed overhead costs. (Related to Chapter 4, Activity-Based Costing.)

You are only responsible for Case # 2 - The case #1 attachment is for information only to assist you in answering Q#3.

Please open the attachment below for additional instructions.

case 2 Cases for Management Decision-Making Greetings CA-9 CA-10 Greetings case 2 Cases for Management Decision-Making The final activity is framing and matting. The expected overhead costs related 4. In Case 1 for Greetings, the overhead allocations using a traditional volume- to framing and matting are $123,900. None of this overhead cost should be allo- based approach were $3.36 for Lance Armstrong, $4.48 for John Elway, and $5.60 for cated to unframed prints. The costs related to framing and matting are relatively Lambeau Field. The total product costs from Case 1 were Lance Armstrong $17.36, fixed because the costs relate to equipment and other costs that do not vary with John Elway $33.48, and Lambeau Field $48.10. The overhead allocation rate for sales volume. As a consequence, like website optimization, you chose to base the unframed prints, such as the unframed Lance Armstrong print in question 3, decreased under ABC compared to the amount of overhead that was allocated under the tradi- cost driver on levels at operating capacity, rather than at the expected sales level. tional approach in Case 1. Why is this the case? What are the potential implications for The cost driver is the number of components. Steel-framed prints have two com- the company? ponents (the print and frame), and wood-framed prints have three components (the print, mat, and frame). The total components at operating capacity would 5. Explain why the overhead cost related to website optimization was first divided into two categories (unframed prints and framed prints) and then allocated based on number of be steel frame 32,000 (or 16,000 X 2) and wood frame 27,000 (or 9,000 X 3,000). prints. 6. When allocating the cost of website optimization, the decision was made to initially allocate Estimated Expected Use of Illustration CA 2-4 the cost across two categories (unframed prints and framed prints) rather than three cat- egories (unframed prints, steel-framed prints, and wood-framed prints with matting). Dis- Activity Cost Driver Overhead Cost Driver Information for activity 4 cuss the pros and cons of splitting the cost between two categories rather than three. Framing and Number of $123,900 Print and frame: 16,000 X 2 = 7. Discuss the implications of using operating capacity as the cost driver rather than the matting cost components 32,000 components at capacity expected units sold when allocating fixed overhead costs. equipment, at capacity Print, mat, and frame: 9,000 X insurance, rent, 3 = 27,000 components at B. (a) Allocate the overhead to the three product categories (unframed prints, steel- and supervisory capacity framed prints, and wood-framed prints with matting), assuming that the estimate labor) Total = 59,000 components of the expected units sold is correct and the actual amount of overhead incurred equaled the estimated amount of $375,200. (b) Calculate the total amount of overhead allocated. Explain why the total overhead of $375,200 was not allocated, even though the estimate of sales was correct. What To summarize, the overhead costs and cost drivers used for each product are are the implications of this for management? expected to be: Steel- Wood- Illustration CA 2-5 Framed, Framed, Summary of overhead costs Cost No with Overhead and cost drivers Activity Driver Unframed Matting Matting Total Cost 1. Picking Number of prints prints 80,000 15,000 7,000 102,000 $ 30,600 2. Inventory Number of selection and components management 80,000 30,000 21,000 131,000 91,700 3. Website Number of 100,000 100,000 25,800 optimization prints at capacity 16,000 9,000 25,000 103,200 4. Framing and Number of matting components at capacity na 32,000 27,000 59,000 123,900 $375,200 Instructions Answer the following questions. 1. Identify two reasons why an activity-based costing system may be appropriate for Wall Decor. 2. Compute the activity-based overhead rates for each of the four activities. 3. Compute the product cost for the following three items using ABC. (Review Case 1 for additional information that you will need to answer this question.) (a) Lance Armstrong unframed print (base cost of print $12). b) John Elway print in steel frame, no mat (base cost of print $16). (c) Lambeau Field print in wood frame with mat (base cost of print $20)Greetmgs c. Greetings Inc.: Job Order Costing Developed by Thomas L. Zeller, Loyola University Chicago, and Paul D. Kt'mmel, University of WisconsinM 1' lwaukee The Business Situation Greetings Inc. has operated for many years as a nationally recognized retailer of greeting cards and small gilt items. It has 1,500 stores throughout the United States located in high-trafc malls. As the stock price of many other companies soared, Greetings' stock price remained at. As a result oia healed 2013 shareholders' meeting, the president of Greetings, Robert Burns, came under pressure from shareholders to grow Greet- ings' stock value. As a consequence of this pressure, in 2014 Mr. Burns called for a fonna] analysis of the company's options with regard to business opportunities. Location was the rst issue considered in the analysis. Greetings stores are located in high-trafc malls where rental costs are high. The additional rental cost was justied, however, by the revenue that resulted From these highly visible locations. In recent years, though. the intense competition from other stores in the mall selling similar merchandise has become a disadvantage of the mall loca- tions. Mr. Burns felt that to increase revenue in the mall locations, Greetings would need to attract new customers and sell more goods to repeat customers. In order to do this, the company would need to add a new product line. However, to keep costs down. the product line sltould be one that would not require much addition al store space. In order to improve earnings, rather than just increase revenues, Greetings would have to carefully manage the costs of this new product line. After careful consideration of many possible prodttcts, the company's man agement found a product that seemed to be a very good strategic t for its exist- ing products: high-quality unframed and framed prints. The critical element of this plan was that customers would pick out prints by viewing them on wide- screen computer monitors in each store. Orders would be processed and shipped [mm a central location. Thus, store size would not have to increase at all. To offer these products, Greetings established a new e-business unit called Wall Decor. Wall Decor is a "prot center"; that is. the manager of the new responsible for decisions affecting both revenues and costs. Wall Decor was designed to distribute unframed and framed print items to each Greetings store on a just-intime (HT) basis. The system w lows: The Wall Decor website allows customers to choose from seve prints. The print can be steel frame and no matti business unit is orks as fol- ral hundred purchased in various forms: unframed, framed with a ng. or framed with a wood frame and matting. When a CA3 , CA-4 Greetings case 1 Cases for Management Decision-Making case 1 Cases for Management Decision-Making Greetings CA-5 customer purchases an unframed print, it is packaged and shipped the same day Manufacturing Overhead Budget Illustration CA 1-2 from Wall Decor. When a customer purchases a framed print, the print is framed Manufacturing overhead at Wall Decor and shipped within 48 hours. Supervisory salaries $100,000 budget for Wall Decor Each Greetings store has a computer linked to Wall Decor's Web server so Factory rent 130,200 Greetings' customers can browse the many options to make a selection. Once a Equipment rent (framing and matting equipment) 50,000 selection is made, the customer can complete the order immediately. Store em- Utilities 20,000 Insurance 10,000 ployees are trained to help customers use the website to shop and to complete 50,00 their purchases. The advantage to this approach is that each Greetings store, Information technology Building maintenance 11,000 through the Wall Decor website, can offer a wide variety of prints, yet the indi- Equipment maintenance 4,000 vidual Greetings stores do not have to hold any inventory of prints or framing Budgeted total manufacturing overhead costs $375,200 materials. About the only cost to the individual store is the computer and high- speed line connection to Wall Decor. The advantage to the customer is the wide variety of unframed and framed print items that can be conveniently purchased and delivered to the home or business, or to a third party as a gift. Wall Decor uses a traditional job order costing system. Operation of Wall Instructions Decor would be substantially less complicated, and overhead costs would be Use the information in the case and your reading from Chapters 1 and 2 of the text to substantially less, if it sold only unframed prints. Unframed prints require no answer each of the following questions. additional processing, and they can be easily shipped in simple protective tubes. 1. Define and explain the meaning of a predetermined manufacturing overhead rate that Framing and matting requires the company to have multiple matting colors and is applied in a job order costing system. frame styles, which requires considerable warehouse space. It also requires 2. What are the advantages and disadvantages of using the cost of each print as a manu- skilled employees to assemble the products and more expensive packaging facturing overhead cost driver? procedures. 3. Using the information in Illustrations CA 1-1 and CA 1-2, compute and interpret the Manufacturing overhead is allocated to each unframed or framed print, based predetermined manufacturing overhead rate for Wall Decor. on the cost of the print. This overhead allocation approach is based on the as- 4. Compute the product cost for the following three items. sumption that more expensive prints will usually be framed and therefore more a) Lance Armstrong unframed print (base cost of print $12). overhead costs should be assigned to these items. The predetermined overhead (b) John Elway print in steel frame, no mat (base cost of print $16). rate is the total expected manufacturing overhead divided by the total expected (c) Lambeau Field print in wood frame with mat (base cost of print $20) cost of prints. This method of allocation appeared reasonable to the account- 5. (a) How much of the total overhead cost is expected to be allocated to unframed prints? ing team and distribution floor manager. Direct labor costs for unframed prints (b) How much of the total overhead cost is expected to be allocated to steel-framed consist of picking the prints off the shelf and packaging them for shipment. For prints? framed prints, direct labor costs consist of picking the prints, framing, matting, c) How much of the total overhead cost is expected to be allocated to wood-framed and packaging. prints? The information in Illustration CA 1-1 for unframed and framed prints was (d) What percentage of the total overhead cost is expected to be allocated to unframed prints? collected by the accounting and production teams. The manufacturing overhead budget is presented in Illustration CA 1-2. 6. Do you think the amount of overhead allocated to the three product categories is rea- sonable? Relate your response to this question to your findings in previous questions. 7. Anticipate business problems that may result from allocating manufacturing overhead based on the cost of the prints. Illustration CA 1-1 Information about prints and Unframed Steel-Framed Print, Wood-Framed Print, framed items for Wall Decor Print No Matting with Matting Volume-expected units 80,000 15,000 7,000 sold Cost Elements Direct materials Print (expected average $12 $16 $20 cost for each of the three categories) Frame and glass $4 $6 Matting Direct labor Picking time 10 minutes 10 minutes 10 minutes Picking labor rate/hour $$12 $12 $12 Matting and framing time 20 minutes 30 minutes Matting and framing rate/hour $21 $21case 2 Cases for Management Decision-Making Greetings CA-7 CA - 8 Greetings case 2 Cases for Management Decision-Making The second activity is inventory selection and management. The estimated of improper product costing. She feels that the costs provided by the company's overhead related to this activity is $91,700. The cost driver for this activity is the traditional job order costing system are inaccurate. From the very beginning, she has carefully managed production and distribution costs. She explains, "Wall number of components per print item. An unframed print has one component, Decor is essentially giving away expensive framed prints, and it appears that it is a steel-framed print has two components (the print and the frame), and a wood- charging the stores too much for unframed prints." In her office she shows you framed print has three components (the print, the mat, and the frame). The total her own product costing system, which supports her point of view. number of components is expected to be 131,000. Your tour of the information technology (IT) department provided additional insight as to why Wall Decor is having financial problems. You discovered that to Illustration CA 2-2 Estimated Expected Use of keep the website running requires separate computer servers and several infor- Information for activity 2 Activity Cost Driver Overhead Cost Driver mation technology professionals. Two separate activities are occurring in the Inventory Number of $91,700 Prints: 80,000 components technology area. First, purchasing professionals and IT professionals spend many selection and components: Print and frame: 15,000 x 2 = hours managing thousands of prints and frame and matting materials. Their management Print (1) 30,000 components tasks include selecting the prints and the types of framing material to sell. They Print and frame (2) Print, mat, and frame; also must upload, manage, and download prints and framing material onto and Print, mat, and frame (3) 7,000 X 3 = 21,000 off of the website. The IT staff tells you much of their time is spent with framing components and matting material. Only a highly skilled IT professional can properly scan a Total = 131,000 components print and load it up to the site so that it graphically represents what the print will look like when properly matted and framed. In addition, you discover that a different team of IT professionals is dedicated The third activity is website optimization. The total overhead cost related to to optimizing the operating performance of the website. These costs are classified website optimization is expected to be $129,000. It was difficult to identify a cost as manufacturing overhead because a substantial amount of work is required to driver that directly related website optimization to the products. In order to re- keep the site integrated with purchasing and production and to safeguard Wall flect the fact that the majority of the time spent on this activity related to framed Decor's assets online. Most time-consuming is the effort to develop and maintain prints, you first split the cost of website optimization between unframed prints the site so that customers can view the prints as they would appear either un- and framed prints. Based on your discussion with the IT professionals, you deter- framed or framed and matted. mined that they spend roughly one-fifth of their time developing and maintain- A discussion with the IT professionals suggests that the time spent develop- ing the site for unframed prints, and the other four-fifths of their time on framed ing and maintaining the site for the unframed prints is considerably less than prints, even though the number of framed prints sold is substantially less than the that required for the framed prints and in particular for the framed and matted number of unframed prints. As a consequence, you allocated $25,800 of the over- prints. Developing and maintaining a site that can display the unframed prints head costs related to website optimization to unframed prints and $103,200 to s relatively straightforward. It becomes more complicated when the site must ramed prints. You contemplated having three categories (unframed, steel-framed, allow the customer to view every possible combination of print with every type and wood-framed with matting), but chose not to add this additional refinement. of steel frame, and immensely more complicated when one considers all of the possible wood frames and different matting colors. Obviously, a very substantial Illustration CA 2-3 portion of the IT professionals' time and resources is required to present the over Estimated Information for activity 3 Expected Use of 1,000 different framing and matting options. Activity Cost Driver Overhead Cost Driver Based on your preliminary findings, you have decided that the company's Website ability to measure and evaluate the profitability of individual products would be optimization: improved if the company employed an activity-based costing (ABC) system. As Unframed Number of prints $ 25,800 Unframed prints: a first step in this effort, you compiled a list of costs, activities, and values. Your at capacity 00,000 print work consisted of taking the original manufacturing overhead cost ($375,200 capacity provided in Case 1) and allocating the costs to activities. You identified four Framed Number of prints $103,200 Framed and/or activities: picking prints; inventory selection and management (includes general at capacity matted prints: management and overhead); website optimization; and framing and matting cost 25,000 print capacity (16,000 includes equipment, insurance, rent, and supervisor's salary). steel; 9,000 wood) The first activity is picking prints. The estimated overhead related to this activity is $30,600. The cost driver for this activity is the number of prints. It is expected that the total number of prints will be 102,000. This is the sum of 80,000 Once the $129,000 of the third activity was allocated across the two broad unframed, 15,000 steel-framed, and 7,000 wood-framed. product categories, the number of prints at operating capacity was used as the cost driver. Note that operating capacity was used instead of expected units sold The overhead costs related to website optimization are relatively fixed because Estimated Expected Use of Illustration CA 2-1 Activity the employees are salaried. If a fixed cost is allocated using a value that varies Cost Driver Overhead Cost Driver Information for activity 1 from period to period (like expected sales), then the cost per unit will vary from Picking prints Number of prints $30,600 (80,000 + 15,000 + 7,000) = period to period. When allocating fixed costs it is better to use a base that does 102,000 prints not vary as much, such as operating capacity. The advantage of using operating capacity as the base is that it keeps the fixed costs per unit stable over time._ ings Greetings Inc.: Activity-Based Costing Developed by Thomas L. Zeiiet; Loyola University Chicago, and Paul D. Kimmei, University oth'sconsinMiiwnnkee ' The Business Situation Mr. Burns, president of Greetings Inc, created the Wall Decor unit of Greetings three years ago to increase the company's revenue and prots. Unfortunately, even though Wall Decors revenues have grown quickly, Greetings appears to be losing money on Wall Dcor. Mr. Burns has hired you to provide consulting services to Wall Dcor's management. Your assignment is to make Wall Dcor a protable business unit. Your rst step is to talk with the Wall Deor work force. From your conver- sations with store managers you learn that the individual Greetings stores are very happy with the Wall Dcor arrangement. The stores are generating additional sales revenue from the sale of unframed and framed prints. They are especially enthusiastic about this revenue source because the online nature of the product enables them to generate revenue without the additional cost of carrying inven- tory. Wall Decor sells unframed and framed prints to each store at product cost plus 20%. A 20% markup on products is a standard policy of all Greetings inter- company transactions. Each store is allowed to add an additional markup to the unframed and framed print items according to market pressures. That is, the sell ing price charged by each store for unframed and framed prints is determined by each store manager. This policy ensures competitive pricing in the respective store locations, an important business issue because of the intense mall competition. While the store managers are generally happy with the Wall Dcor producLs, they have noted a signicant difference in the sales pedormance of the unframed prints and the framed prints. They nd it difcult thsell unframed prints at a competitive price. The price competition in the malls is very intense. On average, stores nd that the prots on unframed prints are very low because the cost for unframed prints charged by Wall Dcor to the Greetings stores is only slightly below what competing stores charge their customers for unframed prints. As a result, the prot margin on unframed prints is very low, and the overall prot earned is small, even with the large volume of prints sold. In contrast, stores make a very good prot on framed prints and still beat the nearest competitor's price by about 15%. That is, the mall competitors cannot meet at a competi- tive price the quality of framed prints provided by the Greetings stores. As a re- sult, store managers advertise the lowest prices in town for high-quality framed prints. One store manager referred to Wall Dcor's computer on the counter as a "cash machine" for framed prints and a \"lemonade stand" for unframed prints. In a conversation with the production manager; you learned that she believes that the relative protability of framed and unframed prints is distorted because CA-6