*Two dollars of gross margin per briefcase? That's ridiculous!" roared Roy Thurmond, president of First-Line Cases, Incorporated "Why do we go on producing those standard briefcases when we're able to make over $11 per unit on our specialty Items? Maybe it's time to get out of the standard line and focus the whole plant on specialty work." Mr. Thurmond was referring to a summary of unit costs and revenues that he had just received from the company's accounting department: Standard Specialty Briefcases Briefcases Selling price per unit Unit product cost Gross margin per unit $ 25.95 23.95 $ 2.00 $ 42.40 31.32 $ 11.08 FirstLine Cases produces briefcases from leather, fabric, and synthetic materials in a single plant. The basic product is a standard briefcase that is made from leather lined with fabric. The standard briefcase is a high-quality item and has sold well for many years. Last year, the company decided to expand its product line and produce specialty briefcases for special orders. These briefcases differ from the standard in that they vary in size, they contain the finest leather and synthetic materials, and they are Imprinted with the buyer's name. To reduce labor costs on the specialty briefcases, automated machines do most of the cutting and stitching. These machines are used to a much lesser degree in the production of standard briefcases. "I agree that the specialty business is looking better and better," replied Beth Mersey, the company's marketing manager. "And there seems to be plenty of demand out there, particularly because the competition hasn't been able to touch our price. Did you know that Velsun Company, our biggest competitor, charges over $48 a unit for its specialty items? Now that's what I call gouging the customer!" A breakdown of the manufacturing cost for each of FirstLine Cases' products is given below: Specialty Briefcases Units produced each month Direct materials: Leather Fabric Synthetic Total materials Direct labor (0.50 DLH and 0.40 DLH @ $11.90 per DLH) Manufacturing overhead (0.5 DLH and 0.4 DLH @ $16.40 per DLH) Total cost per unit Standard Briefcases 20,000 3,500 $ 7.90 $ 11.90 1.90 1.20 6.90 9.80 20.00 5.95 4.76 8.20 6.56 $ 23.95 $ 31.32 Manufacturing overhead is applied to products on the basis of direct labor-hours. The rate of $16.40 per hour was determined by dividing the total manufacturing overhead cost for a month by the direct labor-hours: Predetermined overhead rate = Manufacturing overhead/Direct labor-hours = $186,960/11,400 DLHS = $16.40 per DLH The following additional Information is available about the company and its products: a. Standard briefcases are produced in batches of 1,000 units, and specialty briefcases are produced in batches of 100 units. Thus, the company does 20 setups for the standard Items each month and 35 setups for the specialty Items. A setup for the standard items requires one hour, whereas a setup for the specialty items requires two hours. b. All briefcases are inspected to ensure that quality standards are met. Each month a total of 225 hours is spent Inspecting the standard briefcases and 275 hours is spent Inspecting the specialty briefcases. c. A standard briefcase requires 0.6 hours of machine time, and a specialty briefcase requires 1.3 hours of machine time. d. The company is considering the use of activity-based costing as an alternative to its traditional costing system for computing unit product costs. The activity-based costing system has already been designed and costs have been allocated to the activity cost pools. The activity cost pools and activity measures are detailed below. Activity Cost Pool Purchasing Material handling Production orders and setups Inspection Frane assembly Machine-related Activity Measure Number of orders Number of receipts Setup-hours Inspection-hours Assembly-hours Machine-hours Estimated Overhead Cost $ 9,900 25,200 10,800 20,340 14,800 105,920 $ 186,960