Beztec Limited produces two models of Printers: the Lexon, which Beztec has produced since 2014 and sells for $990; and the Protox, a newer model introduced in 2016 that sells for $1254. Based on the following income statement for the year ended 31 December 2017, senior management at Beztec have decided to concentrate marketing resources on the Protox model and to begin to phase out the Lexon model because the Protox generates a much bigger operating profit per unit.
Income statement for the financial year ended 31December 2017
|Revenues||$23 760 000||$7524 000||$31 284 000|
|Cost of goods sold||15 048 000||5 266 800||20 314 800|
|Gross margin||8 712 000||2 257 200||10 969 200|
|Selling and administrative expense||6 996 000||1 613 700||8 609 700|
|Operating income||$1 716 000||$643 500||$2 359 500|
|Units produced and sold||24 000||6 000|
|Operating income per unit sold||$71.50||$107.25|
Details for cost of goods sold for Lexon and Protox are:
|Costs||Total||Per unit||Total||Per unit|
|Direct materials||$5 491200||$228.80||$3 854 400||$642.40|
|Direct production laboura||475 200||19.80||277 200||46.20|
|Machineb||3 801 600||158.40||475 200||79.20|
|Total direct||$9 768 000||$407.00||$4 606 800||$767.80|
|Production overheadc||$5 280 000||$220.00||$660 000||$110.00|
|Total cost of goods sold||$15 048 000||$627.00||$5 266 800||$877.80|
a Lexon requires 1.5 hours per unit and Protox requires 3.5 hours per unit. The direct production labour rate is $13.20 per hour.
b Machine costs include lease costs of the machine, repairs and maintenance. Lexon requires 8 machine-hours per unit and Protox requires 4 machine-hours per unit. The machine-hour rate is $19.80 per hour.
c Production overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.
Beztec’s management accountant, Sue Smith, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s production overhead costs for the year ended 31December 2017.
|Activity-cost driver (driver quantity)||Total activity costs||Lexon||Protox||Total|
|Soldering (number of solder points)||$1 165725||1 333 125||433 125||1 766 250|
|Shipments (number of shipments)||1 064 250||18 225||4 275||22 500|
|Quality control (number of inspections)||1 534 500||63 225||23 963||87 188|
|Purchase orders (number of orders)||1 176 120||90 113||123 727||213 840|
|Machine power (machine-hours)||71 280||198 000||18 000||216 000|
|Machine set-ups (number of set-ups)||928 125||18 000||15 750||33 750|
|Total production overhead||$5 9400 000|
After completing her analysis, Smith shows the results to Steven Kay, the CEO of Beztec. Kay does not like what he sees. ‘If you show headquarters this analysis, they are going to ask us to phase out the Protox line, which we have just introduced. This whole costing stuff has been a major problem for us. First, Lexon was not profitable and now Protox.
‘Looking at the ABC analysis, I see problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. We can’t afford to phase out either product, please alter the costs produced by the ABC system.’
Smith knows that her numbers are fairly accurate. As a quick check, she calculates the profitability of Lexon and Protox using more and different activity drivers. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is confident that headquarters, knowing that Protox was introduced only recently, will not phase out Protox. She is also aware that a sizeable portion of Kay’s bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Kay to do something. She asks for your advice.
1. Discuss the importance of accurate product costing. In your discussion you should highlight the problems associated with using traditional costing system which Beztec has been using.
2. Calculate the cost driver rates for the various activities identified in the activity-based costing (ABC) system.
3. Calculate the cost of each model under activity based costing.
4. Complete a profitability analysis by calculating the gross profit and gross profit percentage per unit for both models under ABC system.
5. Advise Smith on how she should respond to Kay’s suggestion that she alter the costs produced by the ABC system. You should discuss APES 110 Code of Ethics for Professional Accountants.
6. Using a predetermined overhead rate to allocate overhead cost will most probably result in over/under allocation of overhead coats. Explain why this may happen and three ways to dispose the amount of over/under applied overhead costs.
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