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4-31 Product profitability analysis, unused capacity, traditional activity-based costing

4-31 Product profitability analysis, unused capacity, traditional activity-based costing
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Management Accounting (Atkinson), 5th Edition
4-31 (Product profitability analysis, unused capacity, traditional activity-based costing) Northpack Inc., has recently expanded its line of backpacks to include high-quality, lightweight hiker backpacks. This new model uses more expensive material and takes longer to produce. While a basic school backpack can be cut and sewn together in 30 minutes, a hiker backpack takes 45 minutes to cut and sew together. The school model is produced in batches of 1,000 packs, while the hiker model is produced in batches of 100 packs. Each batch of the school model requires 1 hour of inspection time, and each batch of the hiker model requires 2 hours of inspection time. Using direct labor hours to allocate manufacturing support costs (which in this company include ordering and packaging costs), product profitability is analyzed as follows: ITEM SCHOOL BACKPACKS HIKER BACKPACKS Sales 15.00 $30.00 Less: Direct materials 3.00 10.00 Direct labor 5.00 7.50 Manufacturing support 4.00 6.00 Gross margin $3.00 $6.50 Selling and administrative 1.00 2.00 Profit $2.00 $4.50 Sales volume 90,000 6,000 Jens Schmit, the controller at Northpack, believes that activity based costing may be a more accurate way of measuring the costs of the two models. He has traced manufacturing support costs to the following activity pools and determined the practical capacity levels of the associated activity drivers Activity activity Costs Act. Driver Sch. Mod Hiker Mod Cutting Machines 52,000 Machine hours 9,000 1,125 Sewing Machines 163,300 Direct Labor Hours 45,000 4,500 Packaging-order 8,300 Number of Orders 450 200 related Packaging- volume 150,000 Number of items 90,000 6,000 Orders 14,000 Number of orders 450 200 Inspections 8,400 Hours of inspection ? ? Total $396,000 Selling and administrative expenses are $102,000 fixed business-sustaining costs. Customers pay actual shipping charges, which are not included in these figures. a. The method of assigning costs to individual products does not affect the total manufacturing supports costs. Only the amounts assigned to individual products change. Explain why Jens should care about how support costs are assigned to individual products. B Using activity based costing, calculate the cost per unit for each of the two models and analyze their profitability. c. How might managers use the activity based costing information to enhance the company’s profitability? Consider pricing changes and process changes among your suggestions d. Suppose that practical capacity remains as described earlier but that demand for the school model is on 85,000 units, while demand for the hiker model remains at 6,000 units. For the school model, the cutting machine hours are now 8,500 and the number of orders is 425. Calculate the cost per unit for each of the two models and prepare an income statement similar to Exhibit 4-7 but also showing the cost of unused capacity for each activity. What actions might management take to deal with the unused capacity highlighted in your analysis?



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