Project 4 Acct122: This Case Compares The Traditional Single

Project 4 Acct122this Case Compares The Traditional Single Overhead

This assignment involves analyzing a manufacturing company, Carry All, Inc., which produces standard and specialty briefcases. The focus is on assessing and comparing the traditional overhead allocation method with the activity-based costing (ABC) system. The tasks include calculating overhead applied to each product, determining unit product costs under ABC, evaluating product line profitability, and understanding competitive pricing strategies.

The context provided includes detailed operational data such as production volumes, batch sizes, setup times, inspection hours, machine hours, and activity cost pools. The company currently applies manufacturing overhead based on direct labor-hours but is contemplating switching to ABC for more accurate cost allocation, especially given the distinct differences between standard and specialty products. The analysis aims to inform strategic decisions, including resource focus and pricing strategies.

Paper For Above instruction

Introduction

Manufacturing companies often face challenges in accurately allocating overhead costs to their products, which significantly influences pricing, profitability analysis, and strategic decision-making. Traditional costing methods, typically based on a single cost driver like direct labor-hours, may lead to cost distortions, especially in diversified production environments. This paper discusses Carry All, Inc., and compares its existing traditional overhead allocation system with an activity-based costing approach, evaluating the implications for product profitability and strategic focus.

Traditional Overhead Allocation Method

Carry All currently applies manufacturing overhead using a single rate based on direct labor-hours. The total overhead for the month is $90,000, allocated across 5,625 labor-hours, resulting in an overhead rate of $16 per labor-hour. This uniform rate is straightforward but potentially masks the true consumption of overhead resources by different products and activities.

Under this system, each product's overhead applied is simply the product of the direct labor-hours per unit and the overhead rate. For standard briefcases, with 0.5 hours of labor per unit, the overhead per unit is $8 ($0.5 x $16). Similarly, for specialty briefcases with 0.25 hours of labor, overhead per unit is $4. This method assumes that overhead costs are driven primarily by labor hours, which may not be accurate given the diversity of activities involved.

Activity-Based Costing System

The ABC system refines cost allocation by assigning overhead costs based on multiple activity pools, each with its own cost driver and estimated overhead. The activity pools identified include purchasing, material handling, setup, inspection, frame assembly, and machine-related activities. These activities better reflect the actual resources consumed by each product, especially given their differing production processes.

For example, setup hours differ significantly between standard (1 hour per batch) and specialty (2 hours per batch). Similarly, inspection hours are higher for specialty products. The activity measures include number of orders, receipts, setup hours, inspection hours, assembly hours, and machine hours, each with estimated overhead costs derived from the total of $90,000.

Applying ABC involves calculating the cost per activity measure, such as cost per setup hour or inspection hour, then allocating overhead based on each product's consumption of these activities. This allows for a more precise understanding of product costs and can identify under- or over-costed products under traditional methods.

Calculation of Overhead Using ABC

Based on the provided data, the estimated overhead for each activity is allocated proportionally. For instance, setup activities accounted for a total of 22,000 setup hours, with a total overhead of $12,000, resulting in a cost rate of approximately $0.545 per setup hour. Specialty products, requiring more setup hours, incur higher overhead costs through setup activities. Furthermore, inspection activities totaling 10,000 hours and machine hours totaling 30,000 are allocated similarly, with rates calculated based on total estimated costs and activity measures.

For example, the overhead for a standard briefcase's setup is calculated by multiplying its number of setup hours by the rate per setup hour, and the same applies to specialty items. This detailed allocation demonstrates that specialty briefcases, which involve more complex setups and inspections, incur higher overhead costs than suggested under traditional costing.

Unit Product Cost Analysis

Using the ABC overhead allocations, we determine the unit product costs for both product lines. Standard briefcases, with fewer setup and inspection hours, tend to have lower overhead costs per unit, consistent with the traditional calculation. However, the ABC method often reveals that specialty briefcases are more costly to produce than the traditional overhead rate suggests, due to their higher activity consumption.

In this case, the unit costs under ABC may increase for specialty products, which impacts the gross margin and profitability analysis. The relevant financial data indicates that specialty briefcases, with a selling price of $40 per unit and a gross profit of $14 under traditional costing, might have different profit margins when actual activity consumption is considered.

Profitability Evaluation and Strategic Recommendations

Evaluating product profitability with ABC may alter the company's view of its product lines. Although traditional costing initially shows lower or comparable gross margins for standard and specialty briefcases, ABC may reveal that the high activities associated with specialty items consume more overhead than previously recognized, potentially reducing their profitability.

Given the higher gross margin per unit ($14 vs. $2 for standard) and the premium market positioning of specialty briefcases, it could be advantageous for Carry All to focus more on the specialty segment. This strategic shift aligns with the president’s suggestion to prioritize profitable niche products, especially since there is limited competition in that arena. However, the company should also consider capacity constraints and market demand before reallocating resources exclusively to specialty products.

Moreover, the detailed activity analysis suggests that the company can streamline or better manage setup and inspection processes to further improve margins. Investment in automation or process improvements could reduce activity costs, making specialty briefcases even more profitable and justifying a strategic focus shift.

Understanding Competitive Pricing in the Specialty Market

Sally Henrie’s remark about unmatchable prices for specialty products points to the company's competitive advantage stemming from superior quality, brand reputation, and cost management. The ABC analysis provides insights into the cost structure, revealing that Carry All's higher efficiency in certain activities supports maintaining premium pricing.

Furthermore, the company’s ability to produce specialty briefcases at a lower cost than competitors like Armor, which charges over $50, reinforces its market position. The detailed cost understanding allows Carry All to set prices confidently, knowing the true cost basis, and to defend pricing strategies based on verified cost advantages.

Overall, the implementation of ABC not only enhances cost accuracy but also supports strategic decisions, operational efficiencies, and competitive positioning.

Conclusion

Switching from traditional to activity-based costing provides Carry All with a more accurate picture of product costs, especially for diversified and complex products like specialty briefcases. The analysis indicates that specialty products are more costly to produce than traditional estimates suggest, but they also generate higher gross margins. Strategic focus on these high-margin products, coupled with process improvements, can enhance profitability and competitive advantage. Ultimately, ABC empowers the company to make informed decisions about product lines, resource allocation, and pricing strategies in a competitive market environment.

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