4-20. Distortion of Product Profitability. The Chromosome Manufacturing Company

Question

4-20. Distortion of Product Profitability. The Chromosome Manufacturing Company produces two products, X and Y. The company president, Gene Mutation, is con- cerned about the fierce competition in the market for product X. He notes that competitors are selling X for a price well below Chromosome's price of $12.70. At the same time, he notes that competitors are pricing product Y almost twice as high as Chromosome's price of $12.50. Mr. Mutation has obtained the following data for a recent time period: Number of units Direct materials cost per unit Direct labor cost per unit Direct labor hours Machine hours Inspection hours Purchase orders ProductX Product Y 11,000 $3.23 $2.22 10,000 2,100 80 10 3,000 $3.09 $2.10 2,500 2,800 100 30

Explanation / Answer

Chromosome Manufacturing Company Product X Y Overhead Cost: Selling Price 12.7 12.5 IC 16200 Market Competitor's Price Low High PC 8000 No of Units 11000 3000 MC 49000 DM Cost PU 3.23 3.09 TC 73200 DL Cost PU 2.22 2.1 DLH 10000 2500 Machine Hours 2100 2800 Inspection Hours 80 100 Purchases Order 10 30 DLH PU 0.91 0.83 X Y Total Direct Labor Hours 10000 2500 Total Direct Labor Hours 12500 Total Overhead Cost 73200 Total Direct Labor Hours 12500 Recovery Rate Per DLH 5.856 Product X Y Selling Price 12.7 12.5 Less: Variable Costs: DM Cost PU 3.23 3.09 DL Cost PU 2.22 2.1 Less: Allocated OH 5.32 4.88 (DLH PU* RR Per DLH) Contribution Margin 1.93 2.43 Using ABC System: Overheads: Amount Cost Driver Total Activity Cost Per Driver Inspection Cost 16200 Inspection Hours 180 90 (Amount/Total Activity) Purchaseing Cost 8000 Purchases Order 40 200 (Amount/Total Activity) Machine Cost 49000 Machine Hours 4900 10 (Amount/Total Activity) TC 73200 Total Activity Allocated OH Product X Y X Y Machine Hours 2100 2800 21000 28000 Inspection Hours 80 100 7200 9000 Purchases Order 10 30 2000 6000 Total Allocation 30200 43000 Total Units 11000 3000 Per Unit Cost 2.75 14.33 Product X Y Selling Price 12.7 12.5 Less: Variable Costs: DM Cost PU 3.23 3.09 DL Cost PU 2.22 2.10 Overhead Cost: 2.75 14.33 Contribution Margin 4.50 -7.02 It can be clearly seen why the competitors are charging different prices in the market. For instance see below: For ProductX: Competitors are charging low price below we are getting high conribution margin in ABCsystem as compared to Traditional system So there is scope of reduction of prices there. For ProductY: Competitors are charging High price below we are getting Negative conribution margin in ABCsystem as compared to Traditional system SO we should increase the price of this product

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