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Question;PREMIER PRODUCTS, INC.Premier Products, Inc. manufactures tennis rackets. Premier Products has grownextensively over the past two years. While the company has been very profitable,President Mark Harrison is concerned with its ability to cost products accurately. Someproducts 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 productionprocesses are as efficient as any in the industry, and he is unable to explain the apparenthigh cost of producing some of the products.Harrison agreed with his production manager and is convinced that the cost accountingsystem is at fault. He has hired Tom Arnold, a management consultant, to analyze thefirm's costing system. Arnold has documented the existing costing system. It is a verysimple system that uses a single allocation rate for all overhead costs. The overhead ratefor the year is determined by adding together the budgeted variable and fixed overheadcosts and dividing this sum by the number of budgeted labor hours. The standard cost ofa product is found by multiplying the number of direct labor hours required tomanufacture that product by the overhead rate and adding this quantity to the direct laborand material costs.Arnold is convinced that the company's costing system is partially to blame for some ofthe firm's problems. He has assembled data for four of Premier's products. He has puttogether the actual costs required for each of these products in Table A. These costs willserve as the benchmark against which the results of different allocation schemes can beevaluated.Of course, in real life we could never start out with accurate actual costs - accurate actualcosts would be the end result that we would attempt to determine. But we provide thisinformation as a learning aid to help you to clearly understand the key issues. Table A isas follows:PRODUCTABCDMaterial$15.00$ 5.00$10.00$ 5.00+ Labor30.005.0015.0010.00+Variable OH15.007.505.007.50= Unit var. cost$60.00$17.50$30.00$22.50Fixed overhead$10,000$10,000$12,500$12,500Units produced1,0001,0001,0001,000Unit fixed cost$10.00$10.00$12.50$12.501Total unit cost$70.00$27.50$42.50$35.00The manufacturing processes for these products are structured such that the same laborand equipment can be used to produce products A and B but cannot be used tomanufacture products C and D. Similarly, the labor and equipment used to manufactureproducts 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.ProductLabor hrsper unitVariableOhd/unitNumber ofunitsTotal laborhrsTotal var ohdA6$15.001,0006,000$15,000B17.501,0001,0007,500C35.001,0003,0005,000D27.501,0002,0007,5004,00012,000$35,000TotalThe allocation rate is:2Variable overhead$35,000Fixed overhead45,000Total overhead costs$80,000Labor hours12,000Allocation rate per hour$6.67Using this allocation rate, Arnold calculated the standard cost for the four products.PRODUCTABCDMaterial$15.00$ 5.00$10.00$ 5.00+ Labor30.005.0015.0010.00+Allocated cost40.006.6720.0013.33Total unit cost$85.00$16.67$45.00$28.33The selling prices for the four products are:ABCD$98.00$38.50$59.50$49.00Premier is considering a policy that would discontinue a product if its mark-on is under25%. The mark-on is calculated by taking the selling price, subtracting the product'sstandard cost, and dividing by the standard cost. Harrison is concerned that if the firm'scosting system does not provide accurate cost estimates, products will be dropped thatshould be retained. Arnold calculated that the mark-on for each product using the correctproduct costs in Table A is 40%.3TABLE BPRODUCTABCDSelling price$98.00$38.50$59.50$49.00Unit cost$70.00$27.50$42.50$35.00Profit$28.00$11.00$17.00$14.00Mark-onpercentage40% (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 eachproduct based on allocating the overhead costs using direct labor hours.PRODUCTABCDSelling price$98.00$38.50$59.50$49.00Unit cost$85.00$16.67$45.00$28.33Profit$13.00$21.83$14.50$20.67Mark-onpercentage15%131%32%73%Under the policy of dropping products with mark-ons under 25%, product A would bedropped. Arnold recalculates the allocation rate assuming product A is dropped and themanufacturing capacity is shifted to produce an additional 1,000 units of product B.ProductLabor hrsper unitVariableOhd/unitNumber ofunitsTotal laborhrsTotal var ohdB17.502,0002,000$15,000C35.001,0003,0005,000D27.501,0002,0007,5004,0007,000$27,500Total4The new allocation rate is:Variable overhead$27,500Fixed overhead45,000Total overhead costs$72,500Labor hours7,000Allocation rate per hour$10.36 NOTE: A product's contribution margin is its selling price minus its variable cost per unit.1. 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?2. 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.


Paper#38980 | Written in 18-Jul-2015

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