Konfuzed Inc., produces three products in a single production department. For years, Konfuzed produced a single type of electric motor, the Mechanical A model but last year added two new specialty products, Semi-Auto B and Fully-Auto C. These new products have relatively low annual sales and are produced in relatively short production runs. However, the Semi-Auto B model and particularly the Fully-Auto C have proven to be so profitable that management is contemplating to concentrate on the production and sales of the two new products. The marketing manager observed that it made sense to move into areas where there is little foreign competition and where Konfuzed's ability to respond quickly to customer needs can be exploited.
The production supervisor is opposed to this action, arguing that the profits of Semi-Auto B and Fully-Auto C are deceptive. You have been called to perform a special study on product profitability analysis and has obtain the following information:
UNIT DATA
Selling Price Direct Costs
Mechanical A RM35 RM20
Semi-Auto B 50 30
Fully-Auto C 65 40
After discussions with the production supervisor, you determine that Konfuzed uses highly automated equipment that has fast unit cycle times but relatively slow setup times. Also, the setups are expensive because they require the work of a supervisor and several highly trained production employees. Once set up, however, the machines operate with little attention. This information leads you to question Konfuzed procedure of reassigning production costs on the basis of units produced.
Additional discussions with production personnel and a statistical analysis of historical data reveal the following information pertaining to last year's production and the actual behavior of Konfuzed's manufacturing overhead costs.
Total Job/Batch Setup Time Production
Units Size (Units) per Job Time per Unit
Mechanical A 40,000 5,000 5 hours 0.10 hour
Semi-Auto B 10,000 500 10 hours 0.20 hour
Fully-Auto C 5,000 100 5 hours 0.10 hour
Manufacturing overhead costs:
Setup RM200 per hour x 490 hours = RM 98,000
Operations RM100 per hour x 6,500 hours = 650,000
Total RM748,000
Required:
a) Determine each product's gross profit per unit when manufacturing overhead is assigned on the basis of :
i. units produced, and
ii. operating time.
b) Based on this analysis, what conclusion is management likely to reach about relative profitability? Explain why is the profitability analysis produced differing results.
c) Determine the gross profit per unit when manufacturing overhead is assigned on the basis of the activities that drive overhead costs (activity-based costing).
d) Based on the analysis in requirement c), what conclusion is management likely to reach about relatively profitability? Explain why the outcome is as such.