Greetings Inc. has operated for many years as a nationally recognized retailer o
ID: 2463268 • Letter: G
Question
Greetings Inc. has operated for many years as a nationally recognized retailer of greeting cards and small gift items. It has 1,500 stores throughout the United States located in high-traffic malls.
As the stock price of many other companies soared, Greetings’ stock price remained flat. As a result of a heated 2013 shareholders’ meeting, the president of Greetings, Robert Burns, came under pressure from shareholders to grow Greetings’ stock value. As a consequence of this pressure, in 2014 Mr. Burns called for a formal analysis of the company’s options with regard to business opportunities.
Location was the first issue considered in the analysis. Greetings stores are located in high-traffic malls where rental costs are high. The additional rental cost was justified, however, by the revenue that resulted from these highly visible locations. In recent years, though, the intense competition from other stores in the mall selling similar merchandise has become a disadvantage of the mall locations.
Mr. Burns felt that to increase revenue in the mall locations, Greetings would need to attract new customers and sell more goods to repeat customers. In order to do this, the company needs to add a new product line. However, to keep costs down, the product line should be one that would not require much additional store space. In order to improve earnings, rather than just increase revenues. Greetings would have to carefully manage the costs of this new product line.
After careful consideration of many possible products, the company’s management found a product that seemed to be a very good strategic fit for its existing products: high-quality unframed and framed prints. The critical element of this plan was that customers would pick out prints by viewing them on wide-screen computer monitors in each store. Orders would be processed and shipped from a central location. Thus, store size would not have to increase at all. To offer these products, Greetings established a new e-business unit called Wall Décor. Wall Décor is a “profit center”, that is, the manager of the new business unit is responsible for the decision affecting both revenue and costs.
Wall Décor was designed to distributing unframed and framed print items to each Greeting store on a just-in-time (JIT) basis. The system works as follows: The Wall Décor website allows customer to choose from several hundred prints. The print can be purchased in various forms: unframed, framed with a metal frame and no matting, or framed with a wood frame and matting. When a customer purchases an unframed print, it is packaged and shipped the same day from Wall Décor. When a customer purchases a framed print, the print is framed at Wall Décor and shipped within 48 hours.
Each Greeting store has a computer linked to Wall Décor Web server so Greetings customers can browse many options to make a selection. Once a selection is made, the customer can complete the order immediately. Store employees are trained to help customers use the website and complete the purchase. The advantage to this approach is that each Greetings store, through the Wall Décor website, can offer a wide variety of prints, yet the individual Greetings stores don have to hold any inventory of prints or framing materials. About the only cost to the individual store is the computer and high-speed line connection to Wall Décor. The advantage to the customer is the wide variety of unframed and framed print items that can be conveniently purchased and delivered to the home or business, or to a third party as a gift.
Wall Décor uses a traditional job-order costing system. Operation of Wall Décor would be substantially less complicated, and overhead costs would be substantially less, if it sold only unframed prints. Unframed prints required no additional processing, and they can be easily shipped in simple protective tubes. Framing and matting requires the company to have multiple matting colors and frame styles, which requires considerable warehouse space. It also requires skilled employees to assemble the products and more expensive packaging procedures.
Manufacturing overhead is allocated to each unframed or framed print, based on cost of the print. This overhead allocation approach is based on the assumption that more expensive print will usually be framed and therefore more overhead costs should be assigned to these items. The predetermined overhead rate is the total expected manufacturing overhead divided by the total expected cost of prints. This method of allocation appeared reasonable to the accounting team and distribution floor manager. Direct labor costs for unframed print consist of picking the prints off the shelf and packaging them for shipment. For framed prints, direct labor costs consist of picking the prints, framing, matting, and packaging.
The information on illustration 1-1 for unframed and framed print was collected by the accounting and production teams. The manufacturing overhead budget is presented in Exhibit 1-2 below.
Illustration 1-1
Unframed Print
Steel-Framed Print, No Matting
Wood-Framed Print, with Matting
Volume – expected units sold
80,000
15,000
7,000
Cost Elements
Direct Materials
P12
P16
P20
Frame and glass
P4
P6
Matting
P4
Direct Labor
Picking time
10 minutes
10 minutes
10 minutes
Picking labor rate /hour
P12
P12
P12
Matting and framing time
20 minutes
30 minutes
Matting and framing rate/hour
P21
P21
Illustration 1-2
Manufacturing Overhead Budget
Supervisory salaries
P100,000
Factory rent
130,200
Equipment rent (framing and matting equipment)
50,000
Utilities
20,000
Insurance
10,000
Information technology
50,000
Building maintenance
11,000
Equipment Maintenance
4,000
Budgeted total manufacturing overhead costs
P375,200
1. Define and explained the meaning of a predetermined manufacturing overhead rate that is applied in a job-order costing system.
2. What are the advantage and disadvantages of using the cost of each print as a manufacturing overhead, cost driver?
3. Using the information Exhibit 1-1 and 1-2, compute and interpret the predetermined manufacturing overhead rate for Wall Décor.
4. Compute the product cost for the following three items:
- Lance Armstrong unframed print (base cost of print P12)
- John Elway print in steel frame, no mat (base cost of print P16)
- Lambeau Filed print in wood frame with mat (base cost of print P20)
5. How much of the total overhead cost is expected to be allocated to unframed prints?
6. How much of the total overhead cost is expected to be allocated to steel framed prints?
7. How much of the total overhead cost is expected to be allocated to wood framed prints?
8. What percentage of the total overhead cost is expected to be allocated to unframed prints?
9. Do you think the amount of overhead allocated to the three product categories is reasonable? Relate your response to this question to your findings in previous questions.
10. Anticipate business problems that may result from allocating manufacturing overhead based on the cost of the prints.
THANK YOU!
Unframed Print
Steel-Framed Print, No Matting
Wood-Framed Print, with Matting
Volume – expected units sold
80,000
15,000
7,000
Cost Elements
Direct Materials
P12
P16
P20
Frame and glass
P4
P6
Matting
P4
Direct Labor
Picking time
10 minutes
10 minutes
10 minutes
Picking labor rate /hour
P12
P12
P12
Matting and framing time
20 minutes
30 minutes
Matting and framing rate/hour
P21
P21
Explanation / Answer
GREETING INC.
Answer 1:
A predetermined overhead rate is based on the relationship between estimated annual overhead costs and annual operating activity. It also used to apply the provisions of the estimated cost of manufacturing overhead cost object for a particular reporting period. This rate is often used to help close the books faster, because it avoids the preparation of the actual manufacturing overhead costs as part of period end closing process. However, the difference between the actual and the estimated overhead should be reconciled at least at the end of each fiscal year.
Calculation of Predetermined Rate
= Estimated Annual Overhead Costs ÷ Expected Cost of Prints
There are some concerns with using a predetermined overhead rate, which includes:
Answer 2:
The advantages when using the cost of each print as a manufacturing overhead cost driver are:
The disadvantages when using the cost of each print as a manufacturing overhead cost driver are:
Answer 3: The predetermined manufacturing overhead rate is the total expected manufacturing overhead divided by the total expected cost of prints.
From data in this case, the budgeted total manufacturing overhead costs is $375,200.
Thus, Total Expected Manufacturing Overhead = $375,200
Total Expected Cost of Prints:
Total Cost of Prints: Units of Prints x Cost per Print= Total Cost
Unfinished Print: 80,000 x $12 = $960,000
Steel-Framed, No Matting: 15,000 x $16 = $240,000
Wood-Framed Print, with Matting: 7,000 x $20 = $140,000
Total Expected Cost of Prints = $960,000 + $240,000 + $140,000 = $1,340,000
Therefore, Predetermined Manufacturing Overhead Rate is;
Total Expected Manufacturing Overhead ÷ Total Expected Cost of Prints
Predetermined Manufacturing Overhead Rate = $375,200÷$1,340,000 = 28%
Thus, the predetermined manufacturing overhead rate for Wall Décor is 28%.
This means that, for every $100 of print cost, it is assumed that $28 of manufacturing overhead costs is consumed.
For example, a $12 print will be assigned $3.36 (=$12 x 28%) of manufacturing overhead costs to work in process inventory and to a job.
Answer 4:
Compute the product cost for the three items below:
a)Lance Armstrong unframed print (base cost of print $12)
Direct Materials = Print = $12
Direct Labor = Pick Labor = $12 x (10/60) = $2
Manufacturing Overhead = Picking Prints + Inventory Selection and Management + Website Optimization
= $0.30 + $0.70 + $0.258 = $1.26
Total Cost per print = Direct Materials + Direct Labor + Manufacturing Overhead
= $12 + $2 + $ 1.26 = $15.26
Thus, the product cost for Lance Armstrong unframed print is $15.26
b)John Elway print in steel frame, no mat (base cost of print $16)
Direct Materials = Print + Frame and Glass = $16 + $4 = $20
Direct Labor = Picking Labor + Matting and Framing Labor
= [$12 x (10/60)] + [$21 x (20/60)] = $2 + $7 = $9
Manufacturing Overhead = Picking Prints + Inventory Selection and Management + Website Optimization + Framing and Matting
= $0.30 + ($0.7 x 2) + $4.128 + ($2.10 x 2) = $10.03
Total Cost per Unit = Direct Materials + Direct Labor + Manufacturing Overhead
= $20 + $9 + $10.028 = $39.03
Thus, the product cost for John Elway print in steel frame, no mat is $39.03
c)Lambeau Field print in wood frame with mat (base cost of print $20)
Direct Materials = Print + Frame and Glass + Matting = $20 + $6 + $4 = $30
Direct Labor = Picking Labor + Matting and Framing Labor
= [$12 x (10/60)] + [$21 x (30/60)] = $2 + $10.5 = $12.50
Manufacturing Overhead = Picking Prints + Inventory Selection and Management + Website Optimization + Framing and Matting
= $0.30 + ($0.7 x 3) + $4.128 + ($2.10 x 3) = $12.83
Total Cost per Unit = Direct Materials + Direct Labor + Manufacturing Overhead
= $30 + $12.5 + $12.83 = $55.33
Thus, the product cost for Lambeau Field print in wood frame with mat is $55.33
Answer 5,6,7:
Total overhead cost expected to be allocated to unframed, Steel- framed & Wood- framed prints:
Items
Unframed $
Steel- framed $
Wood- framed $
Total $
Total overhead $
Expected volume
80,000
15,000
7,000
102,000
Unit print cost
12
16
20
48
Total print cost
960,000
240,000
140,000
1,340,000
Overhead allocated
268,800
67,200
39,200
375,200
375,200
Answer 8:
The total overhead cost is expected to be allocated to Unframed prints:
=(268,800/375,200) x 100 = 71.6% or 72%
Answer 9:
The allocation method appears reasonable because it takes into account on one side of the more expensive materials and works for the framed units (print costs are higher) and on the other side of the volume expected (decisely greater for unframed prints).The total allocation results shows a very high overhead allocated cost for unframed is 72% and just 28% for the rest. It would also be considered reasonable if all direct materials were considered, so frame, glass and matting in addition to print cost. The resulting allocation would be:
Items
Unframed $
Steel- framed $
Wood- framed $
Total $
Total overhead $
Expected volume
80,000
15,000
7,000
102,000
Frame, glass, matting cost
4
10
Unit print cost
12
16
20
48
Total print cost
960,000
300,000
210,000
1,470,000
375,000
Overhead allocated
245,028
76,571
53,600
375,200
Overhead allocated %
65.31%
20.41%
1428%
Since the direct labor for framed units is much more expensive in terms of time and cost, an allocation method that could be more reasonable would consider the direct labor, and it could arise:
Items
Unframed $
Steel- framed $
Wood- framed $
Total $
Total overhead $
Expected volume
80,000
15,000
7,000
102,000
Unit DL time
10
30
40
80
Total DL time
800,000
450,000
280,000
1,530,000
375,000
Overhead allocated
196,183
110,352
68,664
375,200
Overhead allocated %
52.28%
2941%
18.30%
Items
Unframed $
Steel- framed $
Wood- framed $
Total $
Total overhead $
Expected volume
80,000
15,000
7,000
102,000
Unit DL cost
2
9
12.5
23.5
Total DL cost
160,000
135,000
87,500
382,500
375,000
Overhead allocated
156,946
132,423
85,830
375,200
Overhead allocated %
41.83%
35.29%
22.88%
Answer 10:
This allocation method is based on the cost of just one factor such as the print cost, implies that theoretically it is the only kind of driver of the factory overhead, which has the possibility of inaccuracy. In the reality there are a lot of drivers of the factory overhead: unique inspections, special handling, special storage and many more. In the case of Wall Décor, “luckily” the type of products are similar, more problems in allocating all the costs of various activities via only one activity would arise in case of more diversity in products. But generally, the result obtained through the print cost allocation method is regardless of the number of activities and the complexity of those activities for the different products, so the result of allocations could be misleading.
= Estimated Annual Overhead Costs ÷ Expected Cost of Prints
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