Bill Lewis, manager of the Thomas Electronics Division, called a meeting with his controller, Brindon Peterson, CMA, and his marketing manager, Patty Fritz. The fol- lowing is a transcript of the conversation that took place during the meeting.
Bill:Brindon, the variable-costing system that you developed has proved to be a big plus for our division. Our success in winning bids has increased, and as a result, our revenues have increased by 25 percent. However, if we intend to meet this year’s profit targets, we are going to need something extra—am I right, Patty?
Patty: Absolutely. While we have been able to win more bids, we still are losing too many, particularly to our major competitor, Kilborn Electronics. If I knew more about their bidding strategy, I think we could be more successful in competing with them.
Bill:Would knowing their variable costs help?
Patty:Certainly. It would give me their minimum price. With that knowledge, I’m sure we could find a way to beat them on several jobs, particularly for those jobs where we are at least as efficient. It would also help us identify where we are not cost-competitive. With this information, we might be able to find ways to increase our efficiency.
Bill:Well, I have good news. I have some data here in these handouts that reveal bids that Kilborn made on several jobs. I have also been able to obtain the direct
Month Receiving Costs Pounds Orders
February $15,400 4,000 140
March 15,300 4,200 100
April 20,104 6,000 100
May 18,800 5,400 120
June 19,168 6,000 40
July 16,960 5,000 80
August 17,100 4,800 120
September 19,470 5,800 100
October 21,000 6,000 180
Required
1. Estimate a cost formula with pounds as the driver and only independent vari- able. If the Dallas plant forecasts 5,200 pounds for the next month, what will the budgeted receiving cost be?
2. Estimate a cost formula with number of orders as the cost driver and only inde- pendent variable. If the Dallas plant forecasts 160 orders for the next month, what will the budgeted setup cost be?
3. Which of the two regression equations do you think does a better job of predict- ing receiving costs? Explain.
4. The multiple regression equation using both pounds and number of orders as independent variables follows:
Y$1,493.27 $2.61 (pounds) $13.71 (orders), R20.998
Using Excel, verify the above formula and then calculate the budgeted cost using the multiple regression equation. Would you recommend using a multiple-driver equa- tion over a single-driver equation? Explain.
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Suspicious
Acquisition of Data;
Ethical Issues LO1
ET
ETHICS
115
C h a p t e r 3 / A c t i v i t y C o s t B e h a v i o r
labor hours worked for many of these jobs. But that’s not all. I have monthly totals for manufacturing costs and direct labor hours for all their jobs for the past 10 months.
Brindon, with this information, can you estimate what the variable manufacturing cost per hour is? If you can, we can compute the variable costs for each job and the markup that Kilborn is using.
Brindon:Yes, an analysis of the data you’re requesting is possible. I have a question, though, before I do this. How did you manage to acquire these data? I can’t imagine that Kilborn would willingly release this information.
Bill:What does it matter how the data were acquired? The fact is, we have this infor- mation, and we have an opportunity to gain a tremendous competitive advantage.
With that advantage, we can meet our profit targets, and we will all end the year with a big bonus.
After the meeting, in a conversation with Patty, Brindon learned that Bill was dating Jackie Wilson, a cost accountant (and CMA) who happened to work for Kilborn.
Patty speculated that Jackie might be the source of the Kilborn data. Upon learning this, Brindon expressed some strong reservations to Patty about analyzing the data.
Required
1. Assume that Bill did acquire the data from Jackie Wilson. Comment on Jackie’s behavior. Which standards of ethical conduct did she violate? (See Chapter 1 for a listing of the ethical code.)
2. Were Brindon’s instincts correct? Should he have felt some reservations about analyzing the data? Would it be ethical to analyze the data? Do any of the IMA standards of ethical conduct apply? What would you do if you were Brindon?
Explain.
Research Assignment
Use the Internet to gather information on one of the theme parks at Disney World—
the Magic Kingdom, Epcot Center, MGM Studios, or the Animal Kingdom. Access this information in the chapter web links at the Interactive Study Center at http://
www.thomsonedu.com/accounting/hansen.
Once you have selected your park, list as many resources as possible and classify them as flexible or committed. Discuss the cost behavior of each. How do you think cost behavior affected the planning for the theme park?
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Cybercase LO2, LO6
Activity-Based Product Costing
l e a r n i n g o b j e c t i v e s
After studying this chapter, you should be able to:
1. Discuss the importance of unit costs.
2. Describe functional-based costing approaches.
3. Tell why functional-based costing approaches may produce distorted costs.
4. Explain how an activity-based costing system works for product costing.
5. Explain how the number of activity rates can be reduced.
chapter 4
Scenario
Makenzie Hepworth, president and owner of SpringBanc, a full-service bank located in Springdale, Arkansas, had just returned from lunch with her brother-in-law, Cameron Hep- worth. Cameron was the controller of the Springdale BelRing plant, a producer of tele- phones. Cameron had described how Hender- son Associates, a regional consulting firm, had replaced BelRing’s direct-labor-based costing system with an activity-based costing system, providing more accurate cost assignments. The more accurate cost assignments had produced some decisions that had significantly improved the profitability of the BelRing plant. That afternoon, after reviewing SpringBanc’s most recent financial reports, Makenzie decided to call Jan Booth, the partner at Henderson Asso- ciates who had led the BelRing project.
Makenzie was hopeful that more accurate costing might help her improve the profitabil- ity of SpringBanc.
Makenzie asked Jan Booth to evaluate the operations, procedures, and policies of the credit department of the bank to see what effect activity-based costing would have on the costs of the department’s products. Nine weeks after Jan agreed to undertake the engagement, Makenzie received the following memo:
MEMO
To: Makenzie Hepworth, President From: Jan Booth, Partner, Henderson
Associates
Subject: Causes of Lackluster Performance Date: August 15, 2008
Our preliminary analysis reveals that many of your problems are related to the use of average-cost information to assess product profitability. Differentiation of services is
increasing in all financial institutions, includ- ing your bank. With differentiation comes increased complexity and product diversity, making average costing an entirely inappro- priate approach to costing out your products.
Your choices of types of products and services offered are rooted in the way you are cur- rently assigning costs to products. You are using a traditional, functional-based costing system, and our analysis shows that it is caus- ing distortions in product costs. The func- tional-based system is indicating that your low-volume products—which typically require more complex procedures and more special handling—are earning a higher margin than your high-volume, less-complex-to-produce products. Using a more accurate cost assign- ment approach, we obtain opposite results. In fact, it appears that 20 percent of your prod- ucts are earning 80 percent of your profits. The under-costing of low-volume products and over-costing of high-volume products are affect- ing your bids and your ability to compete suc- cessfully in your markets. Under-costing of low-volume products and the over-costing of high-volume products affect more than just decisions.
Q u e s t i o n s t o T h i n k A b o u t
1. What are product costs?
2. What role do product costs play in bids?
3. What is meant by a traditional, functional- based costing system? Why might it cause distortions in product costs?
4. Assuming SpringBanc’s problems are founded in the way costs are assigned to products, what can SpringBanc do to solve the problem?