Case 18-3: Safety Monitoring Devices, Inc.

(SMD)

Agenda
1. Calculate the full cost per unit of ODD and TGD using:

The existing costing method Gregs proposed ABC method In-between method

2. Why was Lourdes/Greg interested in company change its cost system? 3. What are the effects, if any, of changing the companys costing method? Specifically, are the differences between these three methods significant in terms of: Effect on individual product cost? Effect on total company profits?

Agenda Cont.
4. Do you think the cost system was a cause of the requests that Lourdes was receiving to discount ODDs back in 2001, when SMD was still a one product, ODD only company? Would it have made sense to start implementing ABC at that time? 5. What should SMD management do regarding its cost system?

1. Calculate full cost per unit of ODD and TGD: The existing costing method

DL Hours:

OGG: 25,000 units(4DL hrs per unit) = 100,000 TGD: 12,500 units(4 DL hrs per unit) = 50,000 Total DL Hours 150,000

OH Rate:

Total OH= 1,430,000 + 1,570,000 = 3,000,000

1. Calculate full cost per unit of ODD and TGD: The existing costing method
Existing Costing Method
OGG Direct Material Cost Direct Labor Cost
Overhead Full Cost Per Unit

TGD $111.00 $64.00

$80.00 $255.00

$88.00 $64.00
$80.00 $232.00

1. Calculate full cost per unit of ODD and TGD: Gregs proposed ABC method
ABC Method
NAME DRIVER ODD COST TGD COST

R&D
MARKETING GEN ADMIN

PRODUCT TYPE
PRODUCT LINE PRODUCTION UNITS PURCHASE ORDERS PART NUMBERS BATCHES

1
1 25,000

60,000
190,000 500,000

4
1 12,500

240,000
190,000 250,000

PURCHASING
MAT HANDLING MACH SET UP

90
18 24

36,000
45,000 36,000

210
32 96

84,000
80,000 144,000

1. Calculate full cost per unit of ODD and TGD: Gregs proposed ABC method
SUPERVISION QUALITY CONT PACK/SHIP MACHINE DEP PLANT DIRECT LABOR HRS PRODUCTION UNITS SHIPMENTS MACHINE HRS PRODUCTION UNITS MACHINE HRS 100,000 25,000 150,000 130,000 50,000 12,500 75,000 65,000

80
75,000 25,000

42,000
90,000 160,000

320
62,500 12,500

168,000
75,000 80,000

MISC
TOTAL OH OH PER UNIT

75,000

60,000
1,499,000 59.96

62,500

50,000
1,501,000 120.08

1. Calculate the full cost per unit of ODD and TGD: In-between method
In-Between Method
Costs per Unit ODD TGD

Direct Material Cost

$ 88.00

$ 111.00

Direct Labor Cost

$64.00

$64.00

OH Cost

$59.96

$120.08

Full Cost per Unit

$ 211.96

$ 295.08

2. Why was Lourdes/Greg interested in changing company cost system?

Lourdes was more focused on changing the cost system because it would allow her a more informed pricing decision making process and help her to plan for more efficient sales strategy. Because Lourdess bonus depended on this margin, her interests were also personal gain.

Greg would have the benefit of improving the manufacturing, supply, and distribution chain, thus reducing company costs to meet his objective of keeping within the stated budget.

3. What are the effects on individual product cost?

The effects are noted in the overhead given to each product. The existing system includes all of the overhead pricing into one cost pool

Distributes the overhead cost equally among all products.

The ABC system uses multiple cost pools: the overhead is distributed differently between the ODD and TGD.

Distributes a smaller amount of overhead under ODD and a larger amount of overhead under TGD.

This strategy makes more sense because of the differences seen in quantities made.

10

3. What are the effects on total company profits?

The total company profits are unaffected by the change in the cost system used. The total overhead amount stays the same because the difference is only the reporting style used.

11

4. Is cost system limitations caused by Lourdes ODD discount requests, when it was an ODD-only company?

Yes, because:

Plant was at overcapacity Costs were directly retained from only single product line: ODD.

Company was also facing increased costs stemming from supporting the R&D
expenses of TGD products. This put constraints on company of their single product line.

Possible Solutions:

Utilize a simple overhead costing approach (because of single product line in 2001)
Do not include the indirect TGD R&D expenses Do not include extra capacity in the overhead rate, use normal capacity numbers instead.

12

5. What should SMD management do regarding the cost system?

The in-between method should be considered in place of the ABC method because the latter drops the cost per unit down considerably in comparison to what they were selling it for.

The in-between method is a more close to the original costs but not so far away that the product seems "cheap".

It may possibly help the company adapt a competitive price range in

comparison to their competitors.

In addition the higher CPU in comparison to the ABC's CPU, is easier for the company to utilize because it's closer to the cost system they

13

had previously been using, meaning it's not so drastic a change.

Agenda
1. Calculate the full cost per unit of ODD and TGD using:

The existing costing method Gregs proposed ABC method In-between method

2. Why was Lourdes/Greg interested in company change its cost system? 3. What are the effects, if any, of changing the companys costing method? Specifically, are the differences between these three methods significant in terms of: effect on individual product cost? Effect on total company profits

14

Agenda Cont.
4. Do you think the cost system was a cause of the requests that Lourdes was receiving to discount ODDs back in 2001, when SMD was still a one product, ODD only company? Would it have made sense to start implementing ABC at that time?

5. What should SMD management do regarding its cost system?

15