INTRODUCTION Businesses – from manufacturing, merchandising and service industries alike – take careful consideration in the analysis of their costing systems in order to be able to set up competitive prices in the market. Misallocation of costs may lead to incorrect price estimates, continuous production of unprofitable products, and ineffective processing schedules. In this case study, we will discuss the costing methods which Zauner Ornaments have used or is currently using and, in conclusion, be able to distinguish the advantages and disadvantages of each costing method. CASE CONTEXT The case seeks to assist Zauner’s comptroller, Yu Chia-yi, in determining the best costing method for their overhead costs. In addition we also aim to understand the following concepts: 1. Differences between traditional costing systems and activity-based costing and; 2. Proper allocation of overhead costs with identification of activities and its associated costs. Zauner Ornaments is launching three different products for their expansion. Yu doubts if the selling prices set by the Sales Department are enough to generate profit for each product line. She analyzes the unit costs for their products to see if the selling prices can cover product costs. Currently, Zauner allocates its factory overhead on the basis of production volume, but there is a significant loss per unit for the small colored glass ornaments. Their Operations Director, David Metz, suggested, in contrast, that overhead allocation be based on prime costs (sum of direct material and direct labor costs) which will result to lower product costs and, therefore, profits per product line. Yu is convinced that both overhead allocations are not accurate enough to trace the costs associated to each product so she tries to divide the support costs using the activity-based costing system. PROBLEM STATEMENT We have identified the issues for the case as follows: 1. Which costing system should Zauner use to allocate the factory overhead in order to accurately capture the product costs? 2. How can we properly identify cost drivers in the allocation of factory overhead? By resolving these issues, we will be able to arrive at a recommendation that will justify the Sales Department’s need to adjust the current selling prices of their products. FRAMEWORK FOR ANALYSIS We will examine the given data from the case and compare the unit costs from the Company’s current costing system (traditional costing) and from activity-based costing. We will also highlight other qualitative data in conjunction with quantitative data which may result to a significant change in our recommendation. The following are the steps we will employ to arrive at our recommendation: 1. Identify activity cost drivers 2. Compute per unit data 3. Compare per-unit plant administration costs considering each of the following: THP Group 2 Case Study for Activity Based Costing Zauner Ornaments
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a. Ending inventory costs b. Direct labor costs
CASE ANALYSIS Using the traditional volume-based costing system, we have computed the maximum overhead cost per based unit using the formula: Maximum overhead cost per unit = Selling price unit – Prime costs per unit The computation is summarized on the table below: he Table 1 – Maximum overhead costs per product line Projected sales units Selling price per unit Prime costs per unit (DM+DL) (b) (c) $ 9.00 $ 4.00 $ 11.00 $ 5.00 $ 17.00 $ 7.00 Maximum overhead cost per unit (d) = (b) – (c) $ 5.00 $ 6.00 $ 10.00 Maximum overhead costs (a) x (d) $ 175,000 $ 300,000 $ 1,000,000 $ 1,475,000 $ 1,170,000 $ 305,000
(a) Small colored glass 35,000 Large colored glass 50,000 Specialty ornaments 100,000 Total maximum overhead cost Actual overhead cost Excess of maximum over actual overhead costs
As seen above, the computed maximum overhead cost is greater than the total actual overhead cost incurred by the Company. This shows that the selling price set by the Sales...