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Perterson Pneumatic Company makes three products. Its Manufacturing plant in Petersburg has three production departments and three service departments
Department Support Cost
Machining (MC) $40000
Plating (PL) 50000
Assembly (AS) 15.000
Purchasing and Inventory(PI) 50000
Setup & Scheduling(SS) 120000
Quality Control (QC) 70000
Support costs are first traced to the six departments. The old cost accounting system allocated the service department costs to the production departments using the following cost drivers :
DEPARTMENT COST DRIVER
Purchasing and Inventory(PI) Material Cost (MAT)
Setup & Scheduling(SS) Direct Labor hours (DLH)
Quality Control (QC) Machine hours (MCH)
The old cost accounting system applied support cost to the three products on the basis
of direct labor hours. A different cost driver rate was determined for each department. The direct labor wage rate at the plant is $10 per hours.
DEPARTMENT GT101 GT102 GT103 MACHINE HOURS
MC 7000 2800 2200 5200
PL 3500 1700 1800 1900
AS 2500 1000 1000 2900
Product PRICE SALES-UNITS ORDERS SETUPS MC PL
GT101 $ 1.25 500.000 25 110 $ 0.30 $ 0.10
GT102 1.20 200.000 10 43 0.25 0.10
GT103 1.30 200.000 40 166 0.28 0.10
The Profitability of the Petersburg plant has been declining for the past 3 years despite the successful introduction of the new product, GT103, which has now captured more than 60% share of its segment of the industry. In an attempt to understand the reason for its declining profitability, the company has appointed a special task force.
The task force is considering a new cost accounting system based on activity analysis. This system employs five cost driver : three department DLH, Setup (SET), and orders (ORD), each department cost pool is divided into homogeneous cost pools identified with a unique driver. The following table present the percent of the deparmental support costs that are put into each of the homogeneous cost pool. The total amounts in the five cost pools are allocated to the three product based on their respective cost drivers :
DEPARTMENT DLH SET ORD
MC 30% 70% 0%
PL 70% 30% 0%
AS 60% 40% 0%
PI 0% 40% 60%
SS ( ? ) ( ? ) ( ? )
QC 0% 70% 30%
Peter Gamle is the leader of the task force responsible for activity-based cost analysis. He interviewed Nola Morris, who was responsible for the setup and scheduling department, to determine the cost drivers for the departmental support costs.
GAMBLE : How many people work in the setup and scheduling department ? (question)
Morris : I have 12 people who work on the setups. 3 more are responsible for production scheduling. I spend most of my time supervising them.
GAMBLE : How do you assign setup workers to production jobs ?(question)
Morris : Almost all the time they set up machines in the machining department. The effort depends only on the number of orders.
GAMBLE : On what does the time spent on scheduling depend ?(question)
Morris : It depends on the number of orders.
GAMBLE : So a large batch or order will require the same amount of setup and scheduling time as a small batch or order.
Morris : Yes, that's right.
Question Required :
A) List the reason that the old cost accounting system at Petersen Pneumatic may be distorting its product costs. ?
B) Determine the product cost per unit using both the old and new costing systems. Show all the intermediate steps including the cost driver rates, amounts in the three new cost pools, and a breakdown of product costs into each of their components.
C) Analyze the profitability of three products. What insight is provided by the new profitability analysis ? What should Petersen Pneumatic do to improve the profitability of its Peterburg plant ? Include marketing and process changes among your recommendations.
D) Mike Meservy is a veteran production manager, and Shannon Corith is a marketing manager with considerable experience as salesperson. Discuss how each is likely to reach to your analysis and recommendations. Explain how their expected reactions may effect the way you will present your recommendations
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