Case 5-49 Activity-Based Costing: Budgeted Operating Margin

Cincinnati cycle company produces two subassemblies, JY-67, used in manufacturing

motorcycles. The company is currently using an absorption costing system that applies
overhead based on direct-labor hours. The budget for the current year ending
ecember !", #$%& is as follows'
CINCINNATI CYCL COM!ANY
Budgeted "tate#ent o$ Operating Margin $or %&'4
(Y-)* +,-)- Tota.
(ales in units. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . .
), $$$
),$$$

"$,$$$
(ales
*evenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. .
+!,&$$,$$$ +&,&$$,$$$ +7,
,$$,$$$
Cost of goods manufactured and sold. . . . . . . .
. . . .
-eginning finished-goods inventory. . . . . . . . . .
. . .
+ &,$,$$$ +
6$$,$$$
+",
$,$,$$$
.dd' irect material. . . . . . . . . . . . . . . . . . . . . .
. . . .
#,$$$,$$$
!,)$$,$$$

),)$$,$$$
irect labor. . . . . . . . . . . . . . . . . . . . . . .
. . . . .
!7$,!7$
",),",6

))),))6
.pplied manufacturing overhead
/
. . . . . .
. . . .
",$,,,$)$
)&&,$#6

",6!#,$76
Cost of goods available for sale. . . . . . . . . . . . .
. . . .
+!,0!0,&#$ +
&,,#0,#"#
+
,,767,6!#
1ess' 2nding finished-goods
inventory. . . . . . . . . . . .
&,$,$$$
6$$,$$$

",$,$,$$$
Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . .
. . . . .
+!,&),,&#$ +
&,##0,#"#
+
7,6,7,6!#
3ross margin. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . .
+
4),,&#$5
+
"7$,7,,
+
""#,!6,
/
.pplied on the basis of direct-labor hours'
6achining. . . . . . . . . . . . . . . . . . . . . . . . .
. . . .
+
,&0,$)6
.ssembly. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . .

&!!,06#
6aterial
handling. . . . . . . . . . . . . . . . . . . . . . .

""!,#$,
7nspection. . . . . . . . . . . . . . . . . . . . . . . . .
. . . .

#!),,)$
Total. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . .
+",6!#,$7
6
Jay *e%ford, Cincinnati Cycle8s president, has been reading about a new type of costing
method called activity-based costing. *e%ford is convinced that activity-based costing
will cast a new light on future profits. .t a result, Jac9 Canfield, the company8s director
of cost management, has accumulated cost pool information for this year shown on the
following chart. This information is based on a product mi% of ),$$$ units of JY-6! and
),$$$ units of *:-67.
Cost !oo. In$or#ation $or %&'4
Cost poo. Activity (Y-)* +,-)-
irect
labor . . . . . . . . . . . . . .
irect-labor hours 4per product
line5. . . . .
"$.$$$ ),$$$
6aterial handling . . . . . . .
. .
;umber of parts 4per
unit5. . . . . . . . . . . . .
) "$
7nspection . . . . . . . . . . . .
. . .
7nspection hours 4per product
line5. . . . . .
),$$$ 7,)$$
6achining . . . . . . . . . . . .
. . .
6achine hours 4per product line5. . . . .
. . .
"),$$$ !$,$$$
.ssembly. . . . . . . . . . . . .
. . .
.ssembly hours 4per product line5. . . .
. . .
6,$$$ ),)$$
7n addition, the following information is pro<ected for the ne%t calendar year, #$%)
(Y-)* +,-)-
(ales 4in units5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . .
),"$$ &,0$$
-eginning inventory, finished goods 4in units5. . . . . . . . . . .
. . . .
,$$ 6$$
2nding inventory, finished goods 4in
units5. . . . . . . . . . . . . . . . . .
7$$ 7$$
=n January ", #$%), *e%ford is planning to increase the prices of JY-6! to +7"$ and
*:-67 to +0"$. 6aterial costs are not e%pected to increase in #$%), but direct labor will
increase by , percent, and all manufacturing overhead costs will increase by 6 percent.
ue to the nature of the manufacturing process, the company does not have any
beginning or ending wor9-in-process inventories.
Cincinnati Cycle Company uses a <ust-in-time inventory system and has materials
delivered to the production facility directly from the vendors. The raw-material inventory
both at the beginning and the end of the month is immaterial and can be ignored for the
purposes of a budgeted income statement. The company uses the first-in, the first-out
4>7>=5 inventory method.
*e?uired'
". 2%plain how activity-based costing differs from traditional product-costing
methods.
#. @sing activity-based costing, calculate the total cost for #$%) for the following
activity cost pools' material handling, inspection, machining, and assembly. 4>or
the total costs, round to the nearest dollar5. Then, calculate the pool rate per unit
of the appropriate cost driver for each of the four activities.
!. Arepare a table showing for each product line the estimated #$%) cost for each of
the following cost elements' direct material, direct labor, machining, assembly,
material handling, and inspection. 4*ound to the nearest dollar5.
&. Arepare a budgeted statement showing the operating margin for Cincinnati Cycle
Company for #$%), using activity-based costing. The statement should show
each product and a total for the company. -e sure to include detailed calculation
for the cost of goods manufactured and sold. 4*ound each amount in the
statement to the nearest dollar5.
Case )-55 using an activity /ased costing syste# to #odi$y /e0avior
12
The Bospital 7nstruments ivision on med 1ife Technology Corporation
manufactures a variety of electronic medical e?uipment. The principal product of
the Bospital 7nstruments ivision is a sophisticated instrument for measuring and
graphically displaying a variety of medical phenomena, such as heart and
respiration rates. The culture throughout the division was primarily engineering-
oriented. =ne result of this culture was that the company8s design engineers
generally designed new product from scratch, rather than relying on modification
of a current design. Chile this approach usually resulted in an DelegantE design
from an engineering standpoint, it often resulted in the use of new or uni?ue parts
that were not already being used in the company8s other products. The strategy
of the Bospital 7nstruments ivision8s management was to position the division
as a products differentiator and price leader, not as the industry8s low-cost
producer. This means that the division generally led the medical instruments
mar9et with new products that e%hibited greater functionality than competing
products and that the products were priced at a premium. The company8s
competitors then would emulate a new product, produce it at a lower cost, and
undercut the 6ed 1ife Technology had moved on to a new product with even
greater functionality. This strategy had been ?uite successful until the Japanese
entered the medical instruments mar9et in a ma<or way. 6ed 1ife technology8s
new competitors were able to set product prices some #) percent below those of
6ed 1ife Technology, while maintaining close to the same level of functionality.
7n order to compete, the Bospital 7nstruments ivision had to lower its prices
below its reported product costs. This resulted in significant losses for the
division.
To remedy the situation, the Bospital 7nstrument ivision8s management began
an e%tensive continuous improvement program. The division changed its
production and inventory management system to a J7T system, ideas of total
?uality control were aggressively pursued and management attempted to
develop an empowered wor9force. .ll of these efforts paid off dramatically.
Bowever, production costs were still relatively high for the industry, and cycle
time were considered too long by management. The general feeling was that in
order to remain competitive in the long run, the division would have to further
lower its productions costs and shorten its production cycle times. .s
management contemplated the high production costs, one problem that 9ept
coming up was the division8s part number proliferation. .s the engineering-
dominated company continued to introduce new products, the number of different
parts and components that had to be stoc9ed in inventory continued to increase.
(ome members of management felt that the division8s cost-reduction goals could
be achieved 4at least partially5 by solving the problem of part number
proliferation.
.s management was pondering the division8s cost-reduction goal, the controller
was contemplating the introduction of a new cost-accounting system. The
controller was thin9ing about introducing activity-based costing and activity-
based management in the Bospital 7nstruments ivision.
*e?uired'
". 2%plain why the problem of part number proliferation could increase the
division8s production costs.
#. 2%plain how long production cycle times could increase the division8s
production costs.
!. Bow could an .-C system be used to help reduce costs by attac9ing the
problem of part number proliferationF .llow yourself to contemplate an
entirely new role for .-C that is ?uite different from the ob<ective of more
accurate product costs. The following specific ?uestions may help in
completing this re?uirement.
a. Chat is the division8s strategy in the mar9etplaceF
b. Bow are prices currently being determinedF
c. oes management really need more accurate product costs, given its
strategy and the reality of mar9et-driven pricesF
d. Chat is the current goal of managementF
e. Chat is 4at least partially5 to blame for high production costsF
f. Cho is 4at least partially5 to blame for high production costsF
g. Bow could an .-C system help solve the problem and reduce production
costsF
&. >ollowing up your answer to re?uirement 4!5, what cost drivers could be
employed to help solve the problem of part number proliferationF Chich costs
driver would wor9 bestF 2%plain.
). Bow could an .-C system help highlight and solve the problem of production
cycle times that are too longF
6. .s succinctly as you can, state how the fundamental role of the .-C system
differs here from the role described in the .erotech illustration used in
Chapter ) and 6.