case c—as

Tradläò ersus Acdvłty-

produces three models, designated as regular, advanced, and deluxe. The company uses a job-order cost Basad Costing Systems
accouoÖag systezzz w:IU æazt t'ac g ovwbeaó aPelÎed ozs the basEs of ćŁi:rect-1øŁior bouts. Tbe systeæ (LO 5-1, 0-2, 5-3, 5-4,.
hasbeen in place with little change for 25 yeørs. Product costs and annual sales data are as follows:
RegulfMode Advance d Mode] Dluxe 1. Re9uląr n10düI, tafget
Annual sales (unlts) 20,000 1,000 Node 10,000 price: $231.00
,..:..........................
Product costs: 2. Advanced model, total unlt
D]rect material ..............,....... .......... $ 20 î 50 $ 84 cost: $875,50
Dlrect labor ........................:.,.,:....... 20 (1 hr at $20) 4ß (2 hr. at $20) 40 (2 hr. at $20)
Manulãcturlng overhead* ,...,......,.... 170 (1 hr, ãt $J70) 340 (2 hF. Bt \Ą TO) 340 (Z hF, at $170)
Total product čost .....................„,....,... $21ß $430 $464

As caleulaŁon of the predatermlû ed nverheaõ fat8’ls as fol| Ws:

MąnufacturIng-overhead budgat:
DBpFøCțgt|gĘI, maøhlnery ,.....,..„....,...,..,.....,......,.,.............,..,................•........ .......•...... '. •...............,.. $2,960,000
MglpltBp [jCğ, mac|ąlnaçy “,..,...,.,.,....„.,...,.........,....,.,......,..................................................................., 24Ooo0
Depreclatlon, t6Xes, and Insurance for factory ...... .... . .. . . 600,000
Egg |ĘØgÇĘg „, „„” “,,.„,,„, ,„.,.....„ ...,,...,.”,..;....,................„....,,,,., , • • ...... . • • • ., •.. , •....,. ,...... 7oo,o00
p /ğg jpg, ¡>øgjy]țjg |d $h]pp|gg ....,....,.,...........,....,.......,........... ..... '' •..,.......... .'•.' '... ..• •.•.....•.... 500,000
)nspec{țon and F6ÇB|F Of ĄĄØȚ$ “„,,„..............,.” ...„. . ...... “.., . ......... . , . ,.. .,.... ..... ...,.. ..., ..... 7õ0,000
ȚyȚ$@ggj ğagd)jpg „ ,. .. ........,., „.” ,.„„„ .,,.. .. ,....,..,,......,... . ..'. . . •.• •..• ,,., ,. .. •.'...•..... ..• •........•,.. 800,000
M} CB||QßBQLI manufactØr}ng oyerhead O8|g .....,..,.,.....,.. ,.,......, .. ,.„ ..........,... ....,. ...,... ,. ..,. ... 5P0,000
T0§d| ,...„..........,..,..„......,...„,.........,........,...,....„......,.„......;............................................................., $7140,000

Dlrect-labor büdget:
RggU|ar ITlode|: 20, OOÒ hOUFa
Advanced model: 2,0O0 hoürs
Deluxe model: . 20,000 hours
Total 42,000 hours

Budgeted overhead $7,140, 000

Predetarmlned overhead rate: Budgeted dlrec |ôÔoF h0urs“ 42,000 hoLłd $170 par hour

Por the past 10 years, the company’s pricing 7omula has been to set each product‘s target price at
110 percent of its full produét cost. Recently, however, the regular-model pump has come under increas-
ing price pressure from offshore competitors. The result Wah that the price on the regular model has been

ered to 220. - - - - „ „
”‘ ’ ” ’ ' ’ ” ”'ÿgs

The company president recendy asked the controller, ‘by can't we compete with these
companies? They’re setting pumps just like our regular mpdel for $212. That’s only two bucks
than our production cost. Are we really that ineffîcient7 What gives?"
The controller responded by sayinø•, “I think this is due to an outmoded product-costing s jstem.
you may remember, I raised a red flag about our system when I came on board last year. Belt the decision
was to keep our current system in place. In my judgment, our product-costing system ib @Ą{Ø g gtjj•
product costs. Ref me run a ley' numbers to demonstrate what I mean.”
Getting the president’s go-anead, the controller compiled the 'basic data needed to implement an
activity-based costing system. these data are displayed in the fo11owijig table. The percøntaq es afe the
proportion of each cost driver consumed by each product line.

Cost Regular Advanced

Actlviły Cost Pool Drlvar Modal Model
I: Depreclatlon, machlnary Machine tlme 39.°/ 13°ß
Malntenance, machlnery
J! Englneerlng Englneerfng hours 6°Ä
Inspectlon and repa!r of defects
Uî: Purchaslng, recelvlng, and shipplnp NumberotmaìedatoMeœ 47%
Materlal handllng
IV: DepraalaĂon, taxes, arid Insurance for factory -actory space usage 42% 15°Â
Miscellaneous manufactudng overhead
 Required:
1.
Compute the target pnée4 for the three pump models, based on the traditional, volume-bastd
product-costing system.
2.
Cnmpute new product costs for the three products, based on the new data collected by tde control-
ler. Roand to the meet Gen L
3.
Calculate a new target price for the trace p aucts, based on the acGvity-based costing system.
Compare the new target price with the current actud se11in• pnce for the regular model pump.
4.
Wnte a memo to the company president explaining what bas heen happening as a result of be
fim’i tradi£onal volume-based product-costing system.
S. What strategic options does management have7 fat do you recnmmend, and why?

I2 Case 5-70.
Refer to the product costs developed in requirement (2) of the preceding problem. Prepare a table show-
of Lracedlrg Case ing how Madison Electric Pump Corporation‘s baditional, volume-based product-coating system dii-
(LO 5-8) toRs be product DDsts of the three pump models. (You may With to ieiC£ to Exhibit 5-10 for guidance.
Because of rounding in the calculation of the product costs, here will be a small rounding error in this
cost distortion analysis as oleh.)

Eklcal Issues Related to
Product-Cost0|stor#o0,
ActlvI§-Based Costing;
Contlrrat!on of Cases 5-d9
and S-70
(L0 5-5; 5-8)
Madison Electric Pump Corporation’s controller, Erin Jackson, developed neW product costs loz the
three pump models using activity-based costing. It was apparent that 1° M’i traditional product-
costing system hfid been undercosting the adv›n‹ea model electric pump by a significant amount. This
was due largely tn the low volume of the advanced model. Before she cold report back to tho presi-
dent Jackson received a phone call from her friend, Alan Tyler. H‹ wa the proauction manager lot the
ahyanced model electric pump. Tyler was upset, and he let Jackson know ih 'Trin, I’ve gotten wind of
your new product cost analysis. There’s no may tbs advanced model costs uywhere near what your
numbers say. For years and years this line has been highly profitable, and its reported product cost was
low. Now you're telling us it costs more than ice what we thought. I just don't buy it.
Jacksofi briefly explained to her f:riend about the principles of activity-based costing and why it
resulted in more accurate product costs, "Alan, the advanced model really is losing money. It simply has
too low a volume to be manufactured efficiently.”
Tyler was even more upset now. “ , If you report these new product cO8ts to the president, he’s
going to discontinue the advanced model. My job’s on the line, Erin! How about inassaging those gup-
bers a little bit. o!s going to know?"

.-‹ ' 'I’ll lmow, Alan. And you’d how,” responded Jackson, 'look, I’ll go oyer my an&ysis again, just
' t make sure I haven’t made an error.”
:§tquirtd:
_ 'pitcuss the ethical issues involved in this scenario.
}. Is the controller, Erin Jackson, acting ethicallyi
. 3. Is the proauction manager, Alan Tyler, achng ethically?
3. What are Jackson’s ethical obligations? To the president? To her friend?
 ETHICAL ISSUES SURRQUNDIŁIG
ACTIVITY-BASED COSTlł\IQ
’ tö“dètermIne whether the fu]İ-Iiñe-prodùcër strategy šon-
Xavler Auto Parts, Inc. manufactures a wide range of autö
parts, which |t se]ls \a auto manLfÏBCturéFż, p'rlmarily In
the United States and C’anada.” The company s. Engme
Parts Divislon operated threo plants In South Od/Dllna and
specialized in engine parts. The division’s Charlotte plant
manufactured soma 6,500 d]fierent parts.
Trouble Brewing
Both the Engine P.arts D]vislon, as w.ell as the Charlotte
plant in particular, had shown satisfactóry profìțabllity for
the past 20 years. In 2013, however, thé Charİofie plant's
profitability took a sharp dow,nward turn, in splte of ris-
¡ng sa]es. The treno continued thròugh the net several
yaars. Management at both the divislon and plant İevels
tool note of the plant’s dec|İnIng profìts ahd heİd several
strategy meetings as a result.
Division Strategy
The Englna Parts Divlslon had alŸYays posltioned ¡tseIł as
the ¡ndustry’s full-line producer. łf a customer wanted a
product, the div¡slon would make It. Although oècasionally
very-low—vo|ume products were discontinued due to lack
of conslstent ordars, the division’s product line rerńalned a
fuIï Ilns o* engine parts. As part of Its stratègy rev]aw, divi-
sion management dcd two thlngs. Fİrst, an actİvlty-òasad
costing study was Initiated in the Charlotte p|ant in ordar
Attention would be glven to identifying inefficient proc
.. . cesses, and process improvements would óe evaluated.
"'’" '
Top Management Response
... . top management baffled at the røcommen ciaif oHs ał tfie
” ABC project team. Sornø top managers dld not believe the
ABC results. ]t just seemed împosslble to them that so
Tiany of the Charlotte plant‘s products were |osers. Other
members of the management team largely accepted
the
validity of the ABC study, but they, too, hesitated to drop
a many products. To do so would most Iik9lÿ daVe rrieant
Charlotte pIaM altogether, while shifting Its ramaining
duction pro-
to the dlvis|on’s other two plants, Some Members
of the ABC project team quietly sąecuİated that some
of
own pay and perks than they were about the well-bslng of
the divisİoq. Iri the final analysis, only a handful
of prod-
U cts were dropped, and then only if‹they were s
•/•4ed
to be unprofitable before the ABC Study Was
undertaken.
’ to 'give manágamént a beńer plcturé ?leach ğroduct line’s
proftablłlty. Second,' a hl9č-leval rëvlëw wás undertaken
tlnued tp make sensa.
Activity-bared Costing
An ĂBC project team Was formed, and a successttJ*Ï pİ|ot
študy was cündüdted on two ofthé Charjoźte plant's prod-
uct lines. Then the ABC project Was extended to thè entire
Chárlotte operation'. Manàgement was a$tońlshsd to fìnd
that fully a quarter of the plant’s products were selling at
a loss. Moreover the”ABC project hlghllghted the extsnt
of the product-line proliferatlon at the Ghár]otte plant. It
turned out that In màny lhstances, uriprofitabls'
had been dropped only )o rreep back Into’ the product
IIne-up after s custömer reğuested It and a.salesperson
àcqulesced. |t became a' joke aróund the ”plant that the
only way tö be súre a drapped product was really gone
was to burn the englneerlng drawings and destroy the
speclál tools raquired to maka It.
ABC Team Recommendations
The ABC project team made sweeping recommenda-
tions to division management, which suggested that the
Charlotte pİant’s product Ilnar be pruned and that roughly
20 percerłt of ¡ts prodUcts be dropped. New Rmphasis
would then be devoted to Increaslng the profitablllty of
the remaining 80 percent of the Charlotte plarit’s products.
Aftermath
The Charlottè äÛt’S Ę i ts continued to deteriorate, as
dld the Ex
prOfäãbiiity. Eventually,
XaVİer’s
Off corporate
the Englne
management *W ks ]ossss by selllng
Parts Dîv|sloø
tD a competitor at ba'rgaln-
basement prices. The dİVÍsíon’
s new owners closed thé
ChãFłotte plant and chi nged the dİVî i• ’• focus ‹a bo a
boutlque producer of Ngh-quaĘy engN¢ pads, whch was
mare In ílne with |ts o’ft COFÇOfatø strategy,
EthİCal Issues
that ethical fssU d y•u 5e e in thls soe
W8UÍd 9Otj resolve Herr;7
descrlbad here, whl|e Ïlctít|ous, Îe
real-w°rld BVOFItS described |n the Ą8C ||îerature.bBsed
OU•t
on several
Anecdotes țn vary.
AND O8EW ägd other sources, as
fon-n dB5crlbed. Ą key source i• the w ïl.
DOWN "Ę cfi rader-Belle
ws" 8ã9B, by R. COoper (Boston: Presldent
College), wĘ]cğ j•øm
a^8 å 8łassÏC case
8W0rIb|ng Issues StJFOLlndłrlg activity-based a ng.
 ..z:c
)-?, 5 7} 5 45 fitäics; Gast System Selektion Aero Dynamics manufactures airplane parts and engines for avariety
of military and tiVllian aircraft. The company is the sole piovider of rocket engines for the U.S.
military that it sells for ffi cost plus a J'% markup.
ACr0 Dynamics’s current cost system is a direct labor-hour-based overlieah allocation system.
Recently, the company conducted a pilot study on the feasibility of using an activity-based Hosting
system. The study shows that the ner ABC system, while more accurate and timely, All result in
the assignment of lower costs to the roclet engines and higlier costs to the company’s other prod-
ucts. Appaiently, the current direct labor-based costing system overcosts the rocket engines and
.undercosts the other products. On hearing of this, top management has decided to scrap the plans
to adopt the ABC system becausc its roc\ct Engine business with the military is significant and the
reduced cost could loser the price and, thus, the profit for this part of Aero Dynamics’s business.
Required As the nanagement accountant participating in this AßC pilot strdy project, what is your
responsibiliq when you leam that top management has decided to cancel the plans for the AßC system?
Can you ignorc your professional ethics cqde in this case! hat could you do?