Each team 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?
