Morelli Electric Motor Corporation manufactures electric motors for commercial use. The company produces three models. designated as standard. deluxe. and heavy-duty. The company uses a job order cost-accounting system with manufacturing overhead applied on the basis of direct-labor hours. The system has been in place with little change for 25 years. Product costs and annual sales data are as follows:

       

	Standard Model	Deluxe Model	Heavy-Duty Model
Annual sales(units)	20.000	1,000	10,000
Product costs:
Raw material	$ 10	$ 25	$ 42
Direct labor	10 (,5hr. at$20)	20 (1hr.at $20)	20 (1hr. at $20)
Manufacturing overhead*	85	170	170
Total product cost	$105	$215	$232

Calculation of predetermined overhead rate:
Manufacturing-overhead budget:
Depreciation, machinery.	$1 .480000
Maintenance, machinery	120,000
Depreciation. taxes. and insurance for factory	300,000
Engineering	350,000
purchasing, receiving and shipping .	250,000
Inspection and repair of defects .	375,000
Material handling .	400,000
Miscellaneous manufacturing overhead costs .	295,000
Total	$3,570,000
Direct-labor budget:
Standard model:	10,000 hours
Deluxe model:	1,000 hours
Heavy-duty model:	10,000 hours
Total	21,000 hours

For the past 10 years. the company's pricing formula has been to set each product's target price at 110 percent of its full product cost. Recently, however, the standard-model motor has come under increasing price pressure from off shore competitors. The result was that the price on the standard model has been lowered to $110.

The company president recently asked the controller, “Why can't we compete with these other companies? They're selling motors just like our standard model for 106 dollars. That's only a buck more than our production cost. Are we really that inefficient? What gives?”

The controller responded by saying, “I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean.”

Getting the president's go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line.

     

		Product Lines
Activity Cost Pool	Cost Driver	Standard Model	Deluxe Mode	Heavy-Duty Model
I. Depreciation. Machinery Maintenance. Machinery	Machine time	40%	13%	47%
II: Engineering Inspection and repair of defects	Engineering hours	47%	6%	47%
III: Purchasing, receiving, and shipping Material handling	Number of material orders	47%	8%	45%
IV: Depreciation. taxes. and insurance for factory Miscellaneous manufacturing overhead	Factory space usage	42%	15%	43%

Required:

1.  Compute the target prices for the three models, based on the traditional, volume-based product costing system.

2.  Compute new product costs for the three products, based on the new data collected by the controller. Round to the nearest cent.

3.  Calculate a new target price for the three products, based on the activity-based costing system. Compare the new target price with the current actual selling price for the standard-model electric motor.

4.  Write a memo to the company president explaining what has been happening as a result of the firm's traditional. volume-based product-costing system.

5.  What strategic options does Morelli Electric Motor Corporation have? What do you recommend. and why?
 

Budgeted overhead Budgeted direct-labor hours $3.570.000 Predetermined overhead rate: $170 per hour 21,000 hours