Case #1
Kumar Boats Limited manufactures and sells fishing boats. All ofthe company’s sales come from two products: the Hauler and theDeluxe. The Hauler is a basic boat built with the minimum requiredcomponents necessary for a successful outing and sells for $24,000.The Deluxe includes additional features unavailable on the Hauler,such as adjustable padded seats, moveable storage boxes, and rodholders, and sells for $29,000. The boats are sold to retailers whothen usually add an outboard motor and a trailer before selling tothe consumer.
Kumar Boats Limited management is meeting to discuss recentfinancial results and to plan for the future. Richard Rajan, thesales manager, advocates for keeping the prices of the two boatsclose in price since they share many similar features (e.g., sizeand weight, seating capacity, etc.). Mary Borkowski, the CEO ofKumar Boats, is concerned and has reviewed the financialinformation for both product lines. She has noticed that salesvolume has been increasing while profits (as a percentage of sales)are decreasing. Mary consulted with her production manager, CraigSteele, who informed her that he is doing his best to control costsbut it is difficult since the proportion of the Deluxe boats beingmanufactured and sold is growing at a much faster rate than salesof the Hauler.
Mary has asked the CFO for more detailed financial informationregarding the sales and manufacturing costs of each product linefor the past year. The following information was provided toMary.
| Hauler | Deluxe |
Direct materials cost per unit | $12,300 | $16,400 |
Direct labour hours per unit | 89 | 116 |
Units sold | 245 | 134 |
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? Manufacturing overhead in the past year was $887,200.
? In the existing system, manufacturing overhead is applied onthe basis of direct labour hours.
? The total direct labour hours for the past year were22,180.
? The hourly rate for direct labour hours is $33.
? Selling and administrative costs for the past year was$1,468,000.
To help Mary gain a better understanding of the costs ofoperations, she asked the CFO to provide her with informationregarding the company’s activities for the past year. Using anactivity-based costing (ABC) approach, the CFO gathered thefollowing information:
Financial data for the two products, based on ABC analysis, isas follows:
Activity Centre | Cost Driver | Activity Cost | Activity Volume |
Materials handling | Number of material moves | $210,800 | 5,270 moves |
Equipment setup | Number of setups | $258,800 | 1,294 setups |
Testing | Number of testing hours | $168,000 | 1,500 testing hours |
Purchasing raw materials | Number of purchase orders | $249,600 | 2,600 purchase orders |
| Hauler | Deluxe |
Direct materials cost per unit | $12,300 | $16,400 |
Direct labour hours per unit | 89 | 116 |
Materials handling movements | 4 | 32 |
Number of setups | 2 | 12 |
Testing hours | 2 | 14 |
Purchase orders required | 3 | 15 |
| | |
Units sold | 245 | 134 |
Required:
(A) Calculate unit cost using the existing costing system (i.e.,using a single, plantwide rate to apply overhead costs). Calculategross and net operating income generated for the company by the twoproducts.
(B) Calculate activity rates, rounding to the nearestdollar.
(C) Calculate unit cost using activity-based costing, andrecalculate gross and net operating
income generated by the two products.
(D) Based on the results above, what advice would you give toMary regarding her observation of increasing sales volume butdecreasing profit?
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Case #2
Hoyoh Skateboards Company (HSC) is looking to acquire anotherskateboard manufacturer, FreeLife Limited. Freelife Ltd. recentlyfiled for bankruptcy and management at HSC believes that they cangenerate a profit from this bankrupt company. FreeLife Ltd. hasaccounts with all of the major sporting goods chains in Canada, asegment of the market where HSC not present.
FreeLife Ltd. manufactures two product lines: traditional boardsand long boards. Traditional boards for $159 each and the longboards for $315 each. In the past year, FreeLife Ltd. produced andsold 245,000 traditional boards and 36,000 long boards.
FreeLife Ltd. uses the absorption method of costing and providedthe information below to HSC. The controller of FreeLife Ltd., whenpresenting this financial information, suggested that Hoyohdiscontinue the traditional board product line after theacquisition. The company uses just-in-time (JIT) to manageinventories and, as a result, beginning and ending inventories arekept near zero (note: at the beginning and end of the prior year,inventories had zero values).
Total production costs for the past year for each product lineare as follows:
| Traditional Boards | Long Boards |
Direct materials | $20,335,000 | $6,904,800 |
Direct labour | $2,940,000 | $360,000 |
Variable manufacturing overhead | $1,960,000 | $115,200 |
Variable selling and administrative costs | $490,000 | $28,800 |
Fixed manufacturing overhead | $14,700,000 | $1,800,000 |
Fixed selling and administrative costs | $2,970,000 | $330,000 |
After reviewing the FreeLife Ltd.’s operational and financialinformation, HSCs management is certain they can eliminate 40% ofFreeLife’s fixed manufacturing overhead and 80% of the fixedselling and administrative costs.
Required:
(A) Using the absorption costing approach, calculate the totalmanufacturing cost per unit for
each product line without the cost savings projected by HSC.What is a likely reason for FreeLife Ltd. controller’s suggestionto eliminate the traditional boards?
(B) Prepare a segmented income statement using variable costing(i.e., contribution margin income statement). Your income statementshould reveal the overall impact of Hoyoh management’s expectedsavings resulting from the merger. Would you suggest that thetraditional boards be discontinued under Hoyoh’s control?
(C) What is a significant disadvantage of JIT with regard toinventory management? If FreeLife Ltd. did have large beginning andending inventories, what might management have done during theprior year to improve the appearance of the company’s incomestatement while looking for a buyer of the company?
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