Assignment - Essendon Electronics: Regal or Monarch?
Essendon Electronics, a division of Elgin Ltd, manufactures a diverse range of electrical products. Its range includes two LCD screen television models: the Monarch, which has been produced since 20XX and sells for $900, and the Regal, a newer model introduced in early 20X0, that sells for $1140. Based on the following income statement for the year ended 30 November 20X1, senior management at Elgin Ltd have decided to concentrate Essendon Electronics' marketing resources on the Regal model and to begin to phase out the Monarch model.
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Essendon Electronics
Income Statement for the financial year ended 30 November 20X1
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Monarch
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Regal
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Total
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Revenues
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$19 800 000
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$4 560 000
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$24 360 000
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Cost of goods sold
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1 2540 000
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3 192 000
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15 732 000
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Gross margin
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7 260 000
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1 368 000
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8 628 000
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Selling and administrative expense
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5 830 000
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978 000
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6 808 000
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Operating profit
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$1 430 000
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$390 000
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$1 820 000
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Units produced and sold
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22 000
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4 000
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Net income per unit sold
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$65.00
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$97.50
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Unit costs for Monarch and Regal are as follows:
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Monarch
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Regal
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Direct materials
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$208
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$584
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Direct manufacturing labour
Monarch (1.5 hours x $12)
Regal (3.5 hours x $12)
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18
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48
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Machine costs*
Monarch (8 hours x $18)
Regal (4 hours x $18)
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144
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72
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Manufacturing overhead other than machine costs**
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200
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100
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Total cost
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$570
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$798
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*Machine costs include lease cost of the machine, repairs and maintenance.
**Manufacturing overhead was allocated to products based on machine-hours at the rate of $25 per hour.
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You have just joined Essendon Electronics as a graduate trainee accountant. You have reviewed the company's existing costing system. You have found that: dramatic changes had occurred within the business environment and the company's manufacturing process over the past 20 years. However, the company's costing system had remained the same since its inception 20 years ago. You believe Activity-based costing (ABC) and activity-based management could help in overcoming the deficiencies in the existing costing system. You have conducted detailed activity analysis, and one-on-one staff interviews. You have noticed that many employees are not happy with the idea of implementing ABC.
You have gathered the following information about the company's manufacturing overhead costs for the year ended 30 November 20X1.
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Units of the cost-allocation base
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Activity centre (cost-allocation base)
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Total activity costs
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Monarch
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Regal
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Total
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Soldering (number of solder points)
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$942 000
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1 185 000
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385 000
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1 570 000
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Shipments (number of shipments: batches)
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860 000
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16 200
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3 800
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20 000
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Quality control (number of inspections)
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1 240 000
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56 200
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21 300
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77 500
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Purchase orders (number of orders: batches)
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950 400
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80 100
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109 980
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190 080
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Machine power (machine hours)
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57 600
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176 000
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16 000
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192 000
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Machine set-ups (number of set-ups: batches)
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750 000
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16 000
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14 000
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30 000
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Total manufacturing overhead
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$4 800 000
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You have discussed your analysis and shown the results to Tom Lockett, Essendon Electronics' divisional manager. Mr Lockett does not seem to be pleased. His comments are: "If you show headquarters this analysis, they are going to ask us to phase out the Regal line, which we have just introduced. This whole costing stuff has been a major problem for us. First Monarch was not profitable and now Regal.
'Looking at the ABC analysis, I see two problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. Second, you used number of set-ups and number of inspections as cost-allocation bases. The numbers would be different, had you used set-up hours and inspection-hours instead. I know that measurement problems precluded you from using these other cost-allocation bases, but I believe you ought to make some adjustments to our current numbers to compensate for these issues. I know you can do better. We can't afford to phase out either product. "
You are aware that a sizable portion of the divisional manager's bonus is based on division revenues. Phasing out either product would adversely affect his bonus. After discussing the issue with Mr Lockett, you feel some pressure to do something about the results.
Required: Prepare a report for the senior management accountant at Essendon Electronics. Your report should include:
a. Calculation of the profitability of the Regal and Monarch models, using ABC.
b. A brief explanation regarding why these numbers differ from the profitability of the Regal and Monarch models calculated using Essendon Electronics' existing costing system.
c. Your response to Mr Lockett's comments and your recommendations on using ABC at Essendon Electronics.
d. The benefits, costs and limitations of adopting ABC.