ACCT2102 Case Study Bo Zhao 43939853

Plum Electronics is a manufacturing service, specializing in the production of televisions.

Currently, Plum Electronics utilizes a conventional process-costing system. Manufacturing
Overhead Costs are allocated from a single cost pool based on a single cost driver, usually
volume-based. In this case, it is the machine hours required per television model. Mammoth
requires more machine-hours than Maximum, being at 8 and 4 hours per unit respectively.
Because of this, Mammoths Manufacturing Overhead Cost is significantly higher than that
of Maximum, with Mammoths being $220 per unit, double that of Maximums.

The issue at hand appears to be cross-subsidization, where low-volume complex products are
being under-costed, while high-volume simple products are being over-costed. Maximum is
under-costed, and currently reported to have a total cost of $877.80 per unit. However,
despite the low machine hours required, it consumes a high level of resources per unit not
accounted for in the costing. Similarly, Mammoth seems to be over-costed at $627, requiring
more machine hours, but a low level of other resources per unit. This is notable in the activity
bases of soldering and purchase orders. Maximum requires 96.25 units of solder points while
Mammoth requires 53.86. Similar, Maximum and Mammoth require 27.5 and 3.64 units of
orders respectively, highlighting the vast disparity in resources consumed.

Jacobs is proposing the use of activity-based costing (ABC). Using ABC, different activities
are identified and individually allocated based on their separate cost pools and cost drivers.

Total Purchase Order Costs (Mammoth) = 1045440*(80100/190080) = $440550

Purchase Order Cost/Unit (Mammoth) = 440550/22000 = $20.03/unit
Total Purchase Order Costs (Maximum) = 1045440*(109980/190080) = $604890
Purchase Order Cost/Unit (Maximum) = 604890/4000 = $151.23/unit

Implementing ABC, the COGS per unit for Mammoth decreased from $627 to $565.01 while
the cost per unit for Maximum increased from $877.80 to $1218.77. The operating incomes
per unit for Maximum and Mammoth are now $133.50 and -$233.72. This implies that with
every unit of Maximum sold, Plum Electronics is making a loss of $233.72 under ABC. It
would be prudent for Plum Electronics to either alter the production process for Maximum, or
to discontinue it to avoid making further losses.

The process-costing system allows Plum Electronics to project a more accurate cost based on
the activities undertaken. This allows Plum Electronics to avoid making a loss, while
appearing to make a profit on paper. ABC also allows Plum Electronics to specifically
isolate certain processes incurring large proportions of the cost and eliminate or change them.
In this case, Plum Electronics could restructure Maximums manufacturing process to reduce
the number of solder points or purchase order, since they appear to be major factors for the
large cost being allocated. However, other activity centres such as machine setups and
shipments do not need to be changed. The number of shipments per unit for Mammoth and
Maximum are 0.74 and 0.95 respectively. The two are not drastically different, and are thus
not the reasons for the disparity in cost.

Jacobs is encountering an agency problem, where the objectives of the managers are not
aligned with that of the shareholders. The managers wish to continue producing Maximum
because they just introduced it, and because Clarks bonus depends on the Maximum.
However, in doing so, Plum Electronics is operating at a loss, which affects the shareholders,
who would want to phase the product out.
ACCT2102 Case Study Bo Zhao 43939853