Instructions for faculty members
Students can work by themselves or in teams of up to four persons, all from the same class. They should not discuss the case with anyone except their teammates (if any). If a student chooses to work alone, the student should not ask others for help. When you collect the case, please do not give out the answers since the information will spread and some students will find out the answer before their case is due.
Mycrone Case ACBU 2223 Spring 2013
The Mycrone Company is a publicly traded corporation that produces different types of digital control systems. My name is Alan Smith and I have worked for this company for the last ten years in the controller s office. I was both an accounting and finance major in university. The company currently produces 300 products and does not anticipate any new products coming out over the next three years. I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional accounting system (where overhead costs are allocated across products at a rate of 500% of direct labor costs) when different products require different amounts of indirect resources. For example, under the traditional system all costs associated with testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor costs. Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor costs. Given that traditional costing systems result in significant cost distortions when determining products costs and given that the firm now has revenues of over $700,000,000 a year, Mycrone has decided to adopt activity based costing over the next year or two.
Mycrone s management has hired Sabley Consulting to help us implement activity based costing. I will be acting as the liaison between our firm and Sabley. As part of the initial implementation phase, I have asked Sabley to derive the costs and profits associated with two of our products, lennair and decase, so that these costs and profits could be compared with the costs and profits under our current traditional accounting system. I picked these products since Mycrone management believe they have very different demands on indirect resources. Further, lennair is sold in large quantities whereas decase is sold in small quantities and traditional accounting systems can cause large cost distortions in different directions for products sold in large and small quantities.
Current information from our existing system on a per unit basis is shown in Exhibit 1.
Exhibit 1 lennair decase Direct material $6 $6 Direct labor hours 0.4 0.4 Direct labor wage rate per hour $25 $25 Sales price per unit $69.40 $97.50
My staff has identified for Sabley five cost pools. Information on those cost pools and the related allocation bases are provided in Exhibit 2. Exhibit 2 Total Costs Allocation Base Value of Allocation Base Equipment setups $20,400,000 Number of setups 60,000 Purchase orders $10,150,000 number of purchase orders 145,000 Machining $61,250,000 number of machine hours 1,750,000 Testing $5,440,000 number of testing hours 640,000 Packaging $10,240,000 number of containers 1,600,000 Although fixed costs are lumped in with variable costs across the five different cost pools, I am aware that machining related costs consists almost exclusively of depreciation costs. Hence, machining costs will be treated as entirely fixed with respect to machine hours. Each machine is used in the production of multiple product lines. The resale value of machines is only affected by the passage of time and not by how much they are used in a given year.
We will assume that costs associated with equipment setups, purchase orders, testing, and packaging are variable with respect to their respective allocation bases. In three years time we will investigate cost behavior patterns within cost pools further to see whether the accounting system can be improved upon by more accurately breaking down costs by their behavior. Currently, we believe our assumptions on cost behavior patterns are quite reasonable.
All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors.
Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the firm never has a beginning work in process inventory or a beginning finished goods inventory. (Hence, the firm never has ending inventories.)
Further information on our two products are provided in Exhibit 3
Exhibit 3 lennair decase annual sales and production in units 135,000 3,500 number of units per batch 75 25 number of purchase orders 300 80 number of machine hours per unit 0.30 1.50 total number of testing hours 12,150 11,200 total number of containers 1,350 1,750
REQUIRED: Students can work by themselves or in teams of up to four persons, all from the same class. Students should not discuss the case with anyone except their teammates (if any). If a student chooses to work alone, the student should not seek help from other students, faculty or other persons. The solution to all problems must be typed. Round off all calculations to two decimal points.
1. (20 Points) Prepare an income statement for lennair and an income statement for decase using the traditional accounting system where overhead is applied at a rate of 400% of direct labor costs. The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
lennair decase Sales $$$ $$$ Direct materials $$$ $$$ Direct labor $$$ $$$ Manufacturing overhead $$$ $$$ Total Costs $$$ $$$ Net operating income $$$ $$$ Average net operating income per unit $$$ $$$
2. (20 Points) Calculate the five activity rates (predetermined overhead rates) under activity based costing.
3. (35 Points) Prepare an income statement for lennair and an income statement for decase using activity based costing. The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
lennair decase Sales $$$ $$$ Direct materials $$$ $$$ Direct labor $$$ $$$ Equipment Setups $$$ $$$ Purchase orders $$$ $$$ Machining $$$ $$$ Testing $$$ $$$ Packaging $$$ $$$ Total Costs $$$ $$$ Net operating income $$$ $$$ Average net operating income per unit $$$ $$$
4. (10 Points) Assume next year that the activity rates (predetermined overhead rates) remain the same as you calculated in question (2). Assume that the demand for lennair is expected to increase significantly. Consequently, the firm expects to produce more batches of lennair next year than this year and the firm plans to produce in batch sizes of 100 rather than 75. Calculate what the equipment setup cost per unit of lennair will be next year if it can be calculated. If it cannot be calculated, then explain in words why the equipment setup cost per unit of lennair cannot be determined in the absence of more information. Excluding your quantitative analysis if any, your explanation should not be more than 1/3 page double spaced with a 12 font size. Your grade will be lowered for poor writing (e.g., grammar).
5. (15 Points) Question 5 is independent of question 4. Assume that the two accounting systems discussed in the case are allowed under GAAP. Also assume next year that the sales volume for each of the firm s products will be the same as this year and that the sales price of each product next year will be the same as the sales price this year. There will be no beginning or ending inventories next year since sales is always equal to production. Finally, assume that total costs next year will be the same as they are this year. If activity based costing is used next year in determining product costs for all of the company s products, would the company s total net operating income next year under activity based costing differ from the company s total net operating income if the company were to continue using the traditional accounting system? Why? Excluding any quantitative analysis, your explanation should not be more than 1/3 page double spaced with 12 font. Your grade will be lowered for poor writing (e.g., grammar).