managers unless there is solid evidence of material improvement in profitability. While the current loss would be reversed, the return on sales is still nominal at 3,500 ÷ $480,000 = .73%.
Exhibit 4-B4: Panel A
Process Map of Traditional Cost System
All Indirect Resources $200,000 All Unallocated Value Chain Costs $80,000 Cost Driver [Direct Labor Hours = 4,500 +
1,000 = 5,500] Direct Materials for Pen Casings $22,500 Direct Labor for Pen Casings $135,000 Direct Materials for Cell Phone Casings $24,000 Direct Labor for Cell Phone Casings $15,000 Pen Casings Sales $360,000 Cell Phone Casings Sales $120,000
Unallocated $80,000
Copyright ?2011 Pearson Education, Inc., Publishing as Prentice Hall. 132
Exhibit 4-B4: Panel B
PRO-FORMA FINANCIAL REPORTS:
TRADITIONAL COST ALLOCATION SYSTEM
STATEMENT OF OPERTING INCOME CONTRIBUTION TO CORPORATE COSTS AND PROFIT [EXTERNAL REPORTING PURPOSE] [INTERNAL STRATEGIC DECISION MAKING AND OPERATIONAL-CONTROL PURPOSE]
Pen Casings Cell Phone Casings Sales $480,000 $360,000 $120,000 1 Cost of goods sold: Direct material 46,500 22,500 24,000 2 Direct labor
150,000 135,000 15,000 Indirect manufacturing 200,000 163,636 3 36,364 4 Cost of goods sold 396,500 321,136 75,364 Gross profit
83,500 $ 38,864 $ 44,636 Corporate expenses (unallocated) 80,000 Operating income $ 3,500 Gross profit margin
17.40% 5
10.80% 37.20%
1. $80,000 × .75 × 2 2. $12,000 × 2 3. $200,000 × [4,500/(4,500 + 1,000)] 4. $200,000 × [1,000/(4,500 + 1,000)] 5. $83,500/$480,000
Copyright ?2011 Pearson Education, Inc., Publishing as Prentice Hall. 133
Perhaps the most important factor bearing on the president’s support is lack of confidence in the accuracy of the cost and hence gross margin figures. She probably will inquire whether the shift in the consumption percentages by the two activities is captured by the traditional costing system. Does the change in allocation rates from 90:10 to 82:18 based on direct labor hour changes
accurately capture the impact of the operational changes? An informal analysis of the controller’s idea might look like the following table. Likely Impact on the Consumption of Resources that Support: Cell-Phone Operational Change Pen Casings Casings Less purchasing work to supply parts for cell-phone casings ? Less engineering design work on cell phone casings ? Less equipment used to support cell-phone production ? Increase in cell-phone production ?
Based on the informal analysis, the President probably would expect the profitability of cell-phone casings to improve and the profitability of pen casings to be unaffected. This disagrees with the numerical analysis. Given the propensity of managers to embrace numerical results, less weight will likely be given this analysis compared to the “objective” numbers. As a result, she may question the validity of the numerical analysis as well as the value of the traditional costing system!
Finally, the focus of improvement efforts should be directly on the pen-casing product line. This initiative deals mostly with the cell-phone line. What can be done to improve profitability of the pen casings? Can prices be raised without losing too much volume? Can operational
improvements be made to lower the indirect manufacturing costs? The controller’s idea is worthy of some support but it does not address the profitability issue head on.
2. Exhibit 4-B4, Panel C on the following page is a process map that can be used to explain the impact of the controller’s idea. Panel D at the end of the solution provides a detailed evaluation of the controller’s idea. Pen Cell-Phone Casings Casings Company Base Gross Profit Percentage* 16.22% (28.63%) 8.07% Plan Gross Profit Percentage** 17.26% 17.81% 17.40% Support of Product Manager? Neutral Strong Support of President? Strong * See the table on p. 139 of the text.
** See panel D of Exhibit 4-B4 that follows.
Copyright ?2011 Pearson Education, Inc., Publishing as Prentice Hall. 134
The controller’s idea will result in a slight increase in the gross profit of the pen-casings line but a dramatic turnaround in the profitability of the cell-phone line. The product manager of pen casings would probably be neutral or slightly positive about the idea because the idea does not focus on operational improvements that directly affect the pen-casings line. The cell-phone
casings manager would give strong support to the idea – this may save his/her job! The president would strongly support this idea while encouraging all managers involved to keep up the good work. Also, note that the numbers agree with the informal analysis – generating confidence in the integrity of the cost accounting system.
Exhibit 4-B4, Panel C Process Map for ABC System
Plant & Machinery $180,000Engineers & CAD Equip. $20,000All Unallocated Value Chain Costs $80,00050P?%Processing Activity $154,000[Direct Labor Hours = 4,500 + 1,000]Direct Labor Direct for Pen Materials for Casings Pen Casings $135,000$22,50020%Production Support Activity $46,000Cost Driver [Distinct Parts = 5 + 11]Direct Materials Direct Labor for Cell Phone for Cell Phone Casings $24,000Casings $15,000SALES $360,000SALES $120,000UNALLOCATED $80,000Copyright ?2011 Pearson Education, Inc., Publishing as Prentice Hall. 135
Exhibit 4-B4: Panel D
PRO-FORMA FINANCIAL REPORTS FOR LOPEZ PLASTICS COMPANY:
ACTIVITY-BASED COST ALLOCATION SYSTEM
STATEMENT OF OPERTING INCOME CONTRIBUTION TO CORPORATE COSTS AND PROFIT [EXTERNAL REPORTING PURPOSE] [INTERNAL STRATEGIC DECISION MAKING AND OPERATIONAL-CONTROL PURPOSE]
Pen Casings Cell Phone Casings Sales $480,000 $360,000 $120,000 Cost of goods sold: Direct material 46,500 22,500 24,000 Direct labor 150,000 135,000 15,000 Processing activity 154,000 126,000 1 28,000 2 Production support activity 46,000 14,375 3 31,625 4 Cost of goods sold 396,500 297,875 98,625 Gross profit
83,500 $ 62,125 $ 21,375 Corporate expenses (unallocated) 80,000 Operating loss
$ 3,500 Gross profit margin 17.40% 17.26%
17.81%
1. $154,000 × [4,500 labor hours/(4,500 labor hours + 1,000 labor hours)] 2. $154,000 × [1,000 labor hours/(4,500 labor hours + 1,000 labor hours)] 3. $46,000 × [5 distinct parts/(5 distinct parts + 11 distinct parts)] 4.
$46,000 × [11 distinct parts/(5 distinct parts + 11 distinct parts)]
Copyright ?2011 Pearson Education, Inc., Publishing as Prentice Hall. 136