Breeden Security Part B.

MBA: 516 Managerial Accounting

Cesar Uauy Julie Lockhart February 23, 2013

After a year of operations, Marlene Baer, the controller of Breeden security decides to do an extended and a more accurate analysis about their performance in 2008. Actual sales were surprising for the company, having 100,000 units sold for RC1 and 80,000 for RC2. People in the organization were optimistic about these sales. On the other hand, Baer decides to update her numbers and to edit some things to see if the expectations that the organization had at the beginning of the year were met. She recognized that the processes used by the parent company of applying direct labor hours may not be the best way of coming with the manufacturing overhead costs together and allocating them to both products. She groups overhead costs by activity and then allocates them to the two products. At the same time, she questions the effectiveness of using direct labor for all the cost drivers that she recognized. On the other hand, she decided that it was too complicated and she was stuck with what the parent company does. Also, the division faced extra cost that was not expected. 1-After looking at Baers original analysis of data there are points that need to be highlighted and others that need to be criticized. The positives aspects of Bears analysis are the way she created the cost pools and utilized activity-based costing for further review. As mentioned previously, Bear distributed three overhead amounts for assembly, fabrication, and packing and shipping in proportion to direct labor. Even though this is the method used by the parent company, Baer knows it is not the most effective one. She could have used machine hours for fabrication since the case states that this activity is highly automated. On the other hand, she should stick with direct labor for assembly, packing and shipping. The main reason is because every order had a customized packing that required extra labor. With that in mind direct labor is the best allocation to use for packing and shipping. Another negative point that Baers analysis has is the way she included the extra expenses. Since RC2 has the majority of orders, the extra expenses are not distributed accordingly. In her analysis RC1 subsidizes extra expenses that are not associated with the production and distribution of this product. Baer is going in the right direction by using the ABC method to determine a more accurate product cost. 2- In order to explain the figures in exhibit 5, one needs to compute the over head rates that Baer used for fabrication, assembly, packing and shipping. In order to determine the overhead rate the following formula must be used: DL Fabrication Assembly 27500 22500 Overhead 19000 12000 21000 OH Rate=OH/DL 0.69 0.53 3.5

Pack & Ship 6000

After knowing the overhead rate, Baer was able to determine the ABC per-unit product cost by performing the following calculations: Parts= total spent divided by the number of units produced; RC1=55000/10000, RC2=32000/5000. Supplies= revised profit estimate, previously used flat rate of $1.4=$21000/15000units but was changed to reflect that RC 2 was more complicated and used more supplies Fabrication labor= estimated DLH manufacturing product/units produced; RC1=18000/10000, RC2=9500/5000. Fabrication Overhead= RC1= (18,000/10,000)*.69=1.244, RC2=(9,500/5,000)*.69=1.313 Assembly labor= estimated direct labor for assembling product/ total units produced; RC1=16,000/10,000, RC2=6,500/5,000 Assembly Overhead= RC1= (16,000/10,000)*.53=.853, RC2= (6,5000/5,000)*.853=.693 Pack & ship labor= estimated direct labor for pack & ship/ total units produced; RC1=1,000/10,000, RC2=5,000/5,000. Packing &shipping Overhead, RC1= (1,000/10,000)*3.5=.35, RC2= (5000/5000)*3.5=3.5 General Operations= {(direct labor per product/ total direct labor)*general operations}/ units produced; RC1= {(35000/56000)39000}/10000 = {.625*39000}/10000=2.4375, RC2= {(21000/56000)39000}/5000=2.92 Selling & admin= consumption rate of selling and admin expense per unit. 3-After performing this calculation, I can reassure that the per-unit product costing under ABC is correct. With that in mind Bear can use the numbers to perform a new budgeted income statement using ABC.
Breeden Security, Inc B 2008 ABC Monthly Budget RC1 RC2 10000 5000 20.00 23.00 200,000.00 115,000.00 $ 55,000.0 $ 35,000.0 $ 62,545.0 $ 152,545.0 $ 32,000.0 $ 21,000.0 $ 49,455.0 $102,455.0

Sales Revenue Produce and Sell selling price Sales Revenue Manufacturing Cost Part Direct Labor Overhead a) Total Manufacturing Cost

Total

$ 315,000.00 $ 87,000.00 $ 56,000.00 $ 112,000.00 $ 255,000.00

Manufacturing Cost U Selling& Administrative Total Expense Profit

15.255

20.49 $ 40,000.00 $ 295,000.00 $ 20,000.00

A) Manufacturing Overhead
Manufacturing Overhead. Supplies Factory Assembly Packing General op Total MOH Rc1 $13,700.0 $ 12,440.0 $ 8,530.0 $ 3,500.0 $ 24,375.0 $62,550.00 Rc2 $ 7,300.00 $ 6,565.00 $3,465.00 $17,500.00 $14,625.00 $49,455.00 total $21,000.0 $19,005.0 $11,995.0 $21,000.0 $39,000.0 $112,000

According to the consumption rates credited to supplies RC2 cost more than RC1. The flat rate used in the original monthly budget did not exactly portray the rate each product consumed supplies. The ABC monthly budget also shows a difference between the manufacturing cost per unit than the one given in Exhibit 1 (16 for RC1 and 19 for RC2). With that in mind, ABC shows that RC2 is even more expensive than what was estimated at the beginning of the year and that RC1 is more profitable than RC2. 4-Another problem with Baers analysis is that comparison cannot be made with the actual volumes or what Baer calls Two Factory Cost. In order to be able to do so, Exhibit 5 has to be completed. With this in mind, per-unit product cost driven by orders must be computed for both products. The table below shows that there is an actual cost driven by orders. Also, this amount includes the extra expenses that were not considered at the beginning of the year when the budget was performed.

5-The table above also provides a comparison between ABC method (budgeted) and Two Factory Cost (actual). When looking at the numbers one can easily identify that product cost differs between both methods. Total manufacturing cost is lower for packing and shipping overhead and general operations because they exclude the 98,000 from table 2. On the other hand, Baer decided to include the extra expenses to order handling which makes cost per order be $400. Once that is divided by the actual units for RC1 and RC2 the cost is added to total manufacturing cost. This fact causes the first difference between the methods because ABC does not include the extra expenses since they were not considered at the beginning of the year. The next difference comes from selling and administrative cost. Under ABC this figure comes from multiplying the monthly estimate times 12 which is 480,000. On the other hand, Two Factory method shows that actual cost was lower which also pushes the total unit cost down in comparison to ABC method. Finally, one needs to remember that the ABC method uses projected monthly sales of 10,000 RC1 and 5,000 RC1 and Two Factory method uses actual annual sales of 10,0000 RC1and 80,000 RC2. 6-After realizing the most of extra cost that came with the RC2 orders, Baer needs to calculate break-even units that would cover the cost per order. This amount of units can be proven and shown by doing four equations. 1234RC2 cost driven by orders/ RC2 Contribution margin. (400*400)/11.17 = 14,375.56 RC2 Break even unites times Sells price 14,375.56* 23= $330,638 RC2 VC * RC2 Break Even u 11.87*14,375.56= $170,638 Break even units- RC2 Break even variable cost= Rc2 Cost Driven by Orders $160,000

These formulas show that in order to cover the $160,000 driven by RC2 orders the division needs to sell 14,376 units monthly.

7-At the time of planning for the next year and create a new budget for 2009 the ABC method can be helpful. In order to see the credibility of the ABC system, Baer needs to see the benefits that come from this method and how it can be used to make more profitable decisions. ABC provides a better way to understand product cost. ABC showed Baer that packing and shipping for RC2 was much more expensive than for RC1. The main reason for this event is that RC2 has a larger amount of customers and orders which includes more packaging and shipping customization. In order to be more profitable for the upcoming year, management could change sales prices depending on the packaging required. If this results to be too complicated then management can assign an index of difficulty for each order which would provide a differentiator for orders. Finally, ABC showed that the company should sell more RC1 units in order to be more profitable. If Baer pays attention to her ABC analysis, she can realize that the company is actually losing money with RC2 mostly because of packing and shipping. By looking at the ABC budgeted volume table in Exhibit 5, one can see that RC1 subsidizes RC2 which becomes more obvious in the Two Factory method.