Zeus Optical is a specialist manufacturer of optical instruments. Zeus has recently expanded its core product market of binoculars into making eyepieces for microscopes/telescopes, and screw-on lenses for digital SLR cameras. The firm believes that it makes little money selling binoculars, and that these new markets have great profit potential.
Somewhat to Zeus€™s surprise, it finds it tough to make money with eyepieces. As of now, the firm is selling the product at a negative profit margin. Yet, Zeus faces intense price pressure in this segment and thinks that it might have to lower prices by 5% or more to stay competitive. The market for binoculars has been stable for several years, and Zeus expects the trends to continue for the near future. Zeus is most excited about entering the market for screw-on lenses for digital SLR cameras. Although current volumes are small (relatively), Zeus believes that there is substantial market potential for this product. Leveraging its excellent reputation for optics and lenses, Zeus believes that it could reach and sustain three times the current volume of this product. This strategy also makes sense financially as this product is the most profitable of the three lines, per the firm€™s accounting records.
The following table provides key information about the product lines.

Currently, the firm incurs $1,161,100 in overhead costs annually. It allocates this overhead among product lines using the number of labor hours used by each product line. Zeus€™s management realizes that moving to camera lenses is a major shift in their product and market focus. Moreover, they know that factory personnel have complained about the increased coordination required for producing lenses. Thus, management wants you to conduct a detailed study of product costs.
You collect the following data.

Analyzing the overhead, you discover the following:

You are wondering how best to allocate these costs into cost pools. You settle on forming five pools.
€¢ Volume-related costs, allocated to products using labor hours.
€¢ Cost related to executing a production order (this would include first part inspections), allocated using the number of batches.
€¢ Costs related to inventory, receiving, and shipping. These costs would be allocated using the number of transactions per product line (= components × number of transactions).
€¢ Costs related to parts administration, which will be equally shared by all product lines.
€¢ Facility-level costs. You decide not to allocate these costs to individual product lines, reasoning that these costs are not controllable at the product level.

Required:
a. Verify the profit margin data reported in the problem text, using the current allocation system.
b. Compute the amounts in the five cost pools and the rate per driver unit for each cost pool.
c. Using the driver rates you computed in part (b), determine the product cost for each product line. That is, compute the profit margin for each product line using activity-based costing.
d. Based on the ABC profit margins, what actions would you recommend for Zeus€™s management.
e. How could you further improve the accuracy of reported product costs, using the ABC system? Be sure to indicate the additional data, if any, which you might need to implement yoursuggestions.

Transcribed Image Text:

EyepiecesBinoculars Camera Lens Sales volume (units) Price Unit variable cost Unit contribution margin Unit profit margin Labor hours/unit 16,000 $53.00 30.00 $23.00 ($2.50) 1.5 20,000 $78.00 45.00 $33.00 0.70 3,000 $160.00 118.00 $42.00 $6.30 2.1 Eyepieces Binulars Camera Lens Sales volume (units) batch size # of batches # of receiving transactions # of products Components 16,000 3,200 5 20 20,000 1,000 20 35 3,000 200 15 50 9 6 20 Item Amund Labor related Machine related Production order First part inspection Inventory management Receiving and shipping Parts administration General administration Total $341,500 273,200 88,000 100,000 110,000 46,250 90,000 112,150 $1,161,100