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Question for answer: Based on the internal cost study, create a new cost system for the Chicago Facility using ABC costing. Identify and explain each activity pool and cost driver (e.g. the XXX costs will be allocated on the basis of YYY because), calculate the allocation rate for each activity pool.

Background Case Information

Chicago Manufacturing Plant

G.G. Toys production process for dolls started with the purchase of raw materials, such as vinyl and resin for the doll bodies and wool and other fibers for doll hair and pajamas, from several suppliers. In its modern Chicago manufacturing facility, the company machine-molded the vinyl and resin into doll bodies, hand- and machine-sewed the various fibers into pajamas and hair for the dolls, and assembled the final product.

Doll bodies for the specialty-branded line were produced to the same specifications as the standard Geoffrey doll in terms of shape and size. However, the pajama outfit of this line was often more ornate than the simple pajama outfit of the standard Geoffrey doll. Thus, more specialized material cuts and hand assembly were required. Also, because of the customized nature of the specialty-branded product, there was much more variety in skin tone, eye color, hair color, and hair length for these dolls than there was for the standard Geoffrey doll.

The same equipment and labor were used for all doll product lines, and production runs were scheduled to match customer shipping requirements. Products were packed and shipped as completed.

The Chicago plant had fallen short on production in the current year. While it had planned for production of 24,900 units, only 24,000 units were produced. However, overall revenue during March was $786,000 (see Exhibit 1), which exceeded forecasted revenue of $765,000. Although happy with the overperformance, plant management did not know how to explain these conflicting results.

Springfield Assembly Plant

Cradles were assembled in the companys small Springfield assembly plant. The plant produced only one model of the cradle and purchased all of the products finished components from several local manufacturers. The cradles were assembled from these finished components completely by hand. Cradles contained several components ranging from the cradle bed and rocking cradle legs to a small speaker that played preset music. To ensure the quality of the finished components coming from G.G.s multiple suppliers, assembly line workers tested the components frequently during the assembly process.

Current Costs System

G.G.s cost accounting system charged each unit of product for direct material and direct labor. Material cost was based on the prices paid for raw materials under annual purchasing agreements. Labor rates, including fringe benefits, were $15 per hour and were charged to product based on the standard run times for each product (see Exhibit 3). Overhead costs in the Chicago plant were allocated to Geoffrey dolls and specialty-branded dolls as a percentage of production-run direct labor cost. The Springfield plant also used production-run direct labor cost to allocate its overhead costs to

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the production of cradles. The company elected not to allocate selling, general, and administrative costs to products.

Internal Cost Study

G.G. Toys had recently commissioned a small internal team to study its overhead costs in both plants. The study revealed the following information:

Workers in the Chicago facility often operated several machines simultaneously once they were set up. Thus, machine-related expenses might relate more to the machine hours of a product than to its production-run labor hours.

A setup was performed in the Chicago facility each time a modification to the dolls was made. For example, to switch from a batch of girl dolls to a batch of boy dolls, a setup was required. Additionally, each time a specialty-branded doll was produced, a separate setup was required to process the raw materials to the required specifications. As the cradles were assembled entirely by hand, there were no setups in the Springfield plant.

For each production run, people in the receiving and production-control departments of the Chicago plant ordered, processed, inspected, and moved each batch of raw materials. This work required the same amount of time regardless of the production run length. The Springfield plant received materials on a just-in-time basis and continuously inspected and moved these materials.

The work in the packaging and shipping areas of both plants had increased during the past couple of years as the company increased the number of customers it served. Each time products were packaged and shipped, about the same amount of work was required, regardless of the number of items in the shipment.

The team had collected the data shown in Exhibit 4 based on operations in March 2000 and felt that this month was typical of ongoing operations with the plant producing at practical capacity. The team decided that plant management and facilities-related costs should continue to be allocated to products in the same way they had been under the old system, as a percentage of production-run direct labor cost.

The team collected data on the standard Geoffrey doll, the specialty-branded doll #106, and the cradle (Exhibits 24). Specialty-branded doll #106 had been ordered by several of G.G. Toys largest customers and made an extremely successful debut in the marketplace. While the Chicago plant produced many different specialty-branded doll models, this particular doll concerned management. Because each retailer required slight alterations to the dolls clothing (e.g., retailer logo on pajamas), a new setup and production run were required each time the clothing design was changed. Because the doll was fairly new, retailers were conservative in their ordering patterns; most ordered fewer units more frequently. Due to these concerns, G.G. management wanted to assess the profitability of the specialty-branded doll #106.

Exhibit 1 G.G. Toys: Operating Results (March 2000) Corporate Corporate Chicago Facility Springfield Facility TOTAL Sales Direct labor Direct materials $786,000 72,000 144,000 $125,400 22,500 36,000 $911,400 94,500 180,000 6,667 Manufacturing Overhead Machine related Plant management and facilities-related costs Setup labor Receiving and production control Packaging and shipping Total manufacturing overhead Selling, general, and administrative Operating income (pretax) 112,000 33,333 13,333 60,000 50,000 $268,666 3,000 3,000 $12,667 112.000 40,000 13,333 63,000 53,000 $281,333 296.650 296,650 $ 58,917 Source: Canewriter, Exhibit 2 Product Profitability Analysis (March 2000) Specialty- Branded Doll #106 Geoffrey Doll Cradles Direct labor cost (S) Direct material cost ($) Manufacturing overhead" ($) Standard unit cost ($) Selling price (s) Margin ($) 3.00 5.00 11.19 19.19 3.75 6.00 13.99 23.74 36.00 34% 7.50 12.00 4.20 23.70 30.00 21% 21.00 Source: Casewriter Chicago overhead allocation percentage of direct labor cont=373% ($268,666/572,000); Springfield overhead allocation percentage of direct labor cont=56% ($12,667/522,500). Exhibit 3 Product Data Product Lines Geoffrey Doll Specialty- Branded Doll Cradles $6 25 DL hours $12 50 DL hours 20 DL hours Materials cost per unit Production-run direct labor per unit Production-run direct labor S/unit @ $15/DL hours (including employee benefits) Machine hours per unit $7.50 $3.00 0.5 $3.75 0.3 0.0 Source: Casewriter. Exhibit 4 Monthly Production and Operating Statistics (March 2000) Chicago Plant Springfield Plant Other Specialty- Branded Dolls Specialty- Branded Doll #106 Geoffrey Doll Total Cradles Total 3,000 3,000 7,500 3,750 4,000 1,200 12,500 6,250 Production (units) Machine hours Setups Production runs Number of shipments 24,000 11,200 160 0 100 10 100 220 Source: Casewriter Exhibit 1 G.G. Toys: Operating Results (March 2000) Corporate Corporate Chicago Facility Springfield Facility TOTAL Sales Direct labor Direct materials $786,000 72,000 144,000 $125,400 22,500 36,000 $911,400 94,500 180,000 6,667 Manufacturing Overhead Machine related Plant management and facilities-related costs Setup labor Receiving and production control Packaging and shipping Total manufacturing overhead Selling, general, and administrative Operating income (pretax) 112,000 33,333 13,333 60,000 50,000 $268,666 3,000 3,000 $12,667 112.000 40,000 13,333 63,000 53,000 $281,333 296.650 296,650 $ 58,917 Source: Canewriter, Exhibit 2 Product Profitability Analysis (March 2000) Specialty- Branded Doll #106 Geoffrey Doll Cradles Direct labor cost (S) Direct material cost ($) Manufacturing overhead" ($) Standard unit cost ($) Selling price (s) Margin ($) 3.00 5.00 11.19 19.19 3.75 6.00 13.99 23.74 36.00 34% 7.50 12.00 4.20 23.70 30.00 21% 21.00 Source: Casewriter Chicago overhead allocation percentage of direct labor cont=373% ($268,666/572,000); Springfield overhead allocation percentage of direct labor cont=56% ($12,667/522,500). Exhibit 3 Product Data Product Lines Geoffrey Doll Specialty- Branded Doll Cradles $6 25 DL hours $12 50 DL hours 20 DL hours Materials cost per unit Production-run direct labor per unit Production-run direct labor S/unit @ $15/DL hours (including employee benefits) Machine hours per unit $7.50 $3.00 0.5 $3.75 0.3 0.0 Source: Casewriter. Exhibit 4 Monthly Production and Operating Statistics (March 2000) Chicago Plant Springfield Plant Other Specialty- Branded Dolls Specialty- Branded Doll #106 Geoffrey Doll Total Cradles Total 3,000 3,000 7,500 3,750 4,000 1,200 12,500 6,250 Production (units) Machine hours Setups Production runs Number of shipments 24,000 11,200 160 0 100 10 100 220 Source: Casewriter

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