answers the questions in the posted Premier Products Case. Answers should show all calculations using
Excel and be thoroughly discussed.
Submit the analysis and discussion in one single Excel file.
The coordinator
should attach the Excel file to a topic titled “Premier Products” in
the Study Group conference.
IMPORTANT: Please be sure to display all communications
between team members in your Study Group Conference.
If you use
email, or an Instant Messenger, or phone, that is fine – but please post the
information in your Study Group Conference.
Your instructor
needs to see all communications between team members in order to verify that
all team members are contributing to the team assignment.
PREMIER
PRODUCTS, INC.
Premier
Products, Inc. manufactures tennis rackets. Premier Products has grown
extensively over the past two years. While the company has been very
profitable, President Mark Harrison is concerned with its ability to cost
products accurately. Some products appear to be very profitable while others,
which should be showing a profit, seem to be losing money. The production
manager is convinced that his production processes are as efficient as any in
the industry, and he is unable to explain the apparent high cost of producing
some of the products.
Harrison agreed
with his production manager and is convinced that the cost accounting system is
at fault. He has hired Tom Arnold, a management consultant, to analyze the
firm’s costing system. Arnold has documented the existing costing system. It is
a very simple system that uses a single allocation rate for all overhead costs.
The overhead rate for the year is determined by adding together the budgeted
variable and fixed overhead costs and dividing this sum by the number of
budgeted labor hours. The standard cost of a product is found by multiplying
the number of direct labor hours required to manufacture that product by the
overhead rate and adding this quantity to the direct labor and material costs.
Arnold is
convinced that the company’s costing system is partially to blame for some of
the firm’s problems. He has assembled data for four of Premier’s products. He
has put together the actual costs required for each of these products in Table
A. These costs will serve as the benchmark against which the results of
different allocation schemes can be evaluated.
Of course, in
real life we could never start out with accurate actual costs – accurate actual
costs would be the end result that we would attempt to determine. But we provide this information as a learning
aid to help you to clearly understand the key issues. Table A is as follows:
PRODUCT
A
B
C
D
Material
$15.00
$ 5.00
$10.00
$ 5.00
+ Labor
30.00
5.00
15.00
10.00
+Variable OH
15.00
7.50
5.00
7.50
= Unit var. cost
$60.00
$17.50
$30.00
$22.50
Fixed overhead
$10,000
$10,000
$12,500
$12,500
Units produced
1,000
1,000
1,000
1,000
Unit fixed cost
$10.00
$10.00
$12.50
$12.50
Total unit cost
$70.00
$27.50
$42.50
$35.00
The
manufacturing processes for these products are structured such that the same
labor and equipment can be used to produce products A and B but cannot be used
to manufacture products C and D. Similarly, the labor and equipment used to
manufacture products C and D cannot be used for A and B.
The company has
the capacity to produce:
(1) 1,000 units
of product A and 1,000 units of product B, or
(2) 2,000 units
of product A, or
(3) 2,000 units
of product B; or
(4) Any linear
combination of products A and B.
The same is true
for products C and D. The company has the capacity to produce:
(1) 1,000 units
of product C and 1,000 units of product D, or
(2) 2,000 units
of product C, or
(3) 2,000 units
of product D; or
(4) Any linear
combination of products C and D.
Product
Labor hrs per unit
Variable Ohd/unit
Number of units
Total labor hrs
Total var ohd
A
6
$15.00
1,000
6,000
$15,000
B
1
7.50
1,000
1,000
7,500
C
3
5.00
1,000
3,000
5,000
D
2
7.50
1,000
2,000
7,500
Total
4,000
12,000
$35,000
The allocation
rate is:
Variable overhead
$35,000
Fixed overhead
45,000
Total overhead costs
$80,000
Labor hours
12,000
Allocation rate per hour
$6.67
Using this
allocation rate, Arnold calculated the standard cost for the four products.
PRODUCT
A
B
C
D
Material
$15.00
$ 5.00
$10.00
$ 5.00
+ Labor
30.00
5.00
15.00
10.00
+Allocated cost
40.00
6.67
20.00
13.33
Total unit cost
$85.00
$16.67
$45.00
$28.33
The selling
prices for the four products are:
A
B
C
D
$98.00
$38.50
$59.50
$49.00
Premier is
considering a policy that would discontinue a product if its mark-on is under
25%. The mark-on is calculated by taking the selling price, subtracting the
product’s standard cost, and dividing by the standard cost. Harrison is
concerned that if the firm’s costing system does not provide accurate cost
estimates, products will be dropped that should be retained. Arnold calculated
that the mark-on for each product using the correct product costs in Table A is
40%.
TABLE B
PRODUCT
A
B
C
D
Selling price
$98.00
$38.50
$59.50
$49.00
Unit cost
$70.00
$27.50
$42.50
$35.00
Profit
$28.00
$11.00
$17.00
$14.00
Mark-on
percentage
40% (28/70)
40% (11/27.50)
40% (17/42.50)
40% (14/35)
Arnold then
calculated the mark-on for the four products using the standard cost for each
product based on allocating the overhead costs using direct labor hours.
PRODUCT
A
B
C
D
Selling price
$98.00
$38.50
$59.50
$49.00
Unit cost
$85.00
$16.67
$45.00
$28.33
Profit
$13.00
$21.83
$14.50
$20.67
Mark-on
percentage
15%
131%
32%
73%
Under the policy
of dropping products with mark-ons under 25%, product A would be dropped.
Arnold recalculates the allocation rate assuming product A is dropped and the manufacturing
capacity is shifted to produce an additional 1,000 units of product B.
Product
Labor hrs per unit
Variable Ohd/unit
Number of units
Total labor hrs
Total var ohd
B
1
7.50
2,000
2,000
$15,000
C
3
5.00
1,000
3,000
5,000
D
2
7.50
1,000
2,000
7,500
Total
4,000
7,000
$27,500
The new
allocation rate is:
Variable overhead
$27,500
Fixed overhead
45,000
Total overhead costs
$72,500
Labor hours
7,000
Allocation rate per hour
$10.36
QUESTIONS
1. If Premier
maintains its rule about dropping products with a mark-on below 25%, which
additional products, if any, will it drop?
2. If you decide
to drop additional product(s), recalculate the allocation rate for the new
product mix. Keep repeating Question 1 until you reach a conclusion. What is
that conclusion? Is there a pattern emerging in the order in which products are
being dropped?
3. The firm
allocates only variable product costs to each product based on direct labor
hours. What is the contribution margin for each product? Which product or
products should the company produce if it wants to maximize the contribution
margin for all of the products it produces? What would be the impact on
profits? How accurate is this method of allocating costs? If Premier stopped
producing some products in its product line of tennis rackets, what might
happen to the demand for the surviving products?
NOTE: A
product’s contribution margin is its selling price minus its variable cost per
unit.
4. What would
happen if the firm modified its costing system so that all variable costs were
traced to the product accurately, but fixed costs were allocated using the
existing system? Compute the cost for each product using this allocation
process. What would be the impact on profits? How accurate is this method of
allocating costs?
5. What would
happen if the firm modified its costing system so that it contained two cost
pools, one containing the overhead costs associated with Products A and B and
the other overhead costs associated with Products C and D, and then allocated
these overhead pools on the basis of direct labor hours? Compute the cost for
each product using this allocation process. What would be the impact on
profits? How accurate is this method of allocating costs?
6. Under what
conditions would direct labor hours accurately allocate Premier’s indirect
costs to its four products? What are the characteristics of a cost accounting
system that accurately allocates a company’s fixed and variable indirect costs
to its products?
7. Tom Arnold
was hired to find accurate costs and a method of allocating that allows
decisions to improve profitability.
Compare the profits and accuracy of all cost allocation schemes based on
Tom Arnold’s initial reason for being hired.
8. Do the
company costing systems cause a problem?
9.
What is the purpose of a cost
allocation system?
