Gigabyte, Inc. manufactures three products for the computer industry: Gismos (product G): annual sales, 8,000 units Thingamajigs (product T): annual sales, 15,000 units Whatchamacallits (product W): annual sales, 4,000 units The company uses a traditional, volume-based product-costing system with manufacturing over-head applied on the basis of direct-labor dollars. The product costs have been computed as follows: Product G Product T Product W Raw material ..........................$ 35.00 $52.50 $17.50 Direct labor 16(.8 hr.at $20) 12(.6 hr at $20) 8(.4 hr at $20) Manufacturing overhead* ......140.00 105.00 70.00 Total product cost ..................$191.00 $169.50 $95.50 *Calculation of predetermined overhead rate: Manufacturing overhead budget: Machine setup...................................................................................$ 5,250 Machinery.................................................................................................1,225,000 Inspection ....................................................................................................525,000 Material handling.....................................................................................875,000 Engineering ........................................................................................... 344,750 Total ........................................................................................................$2,975,000 Direct-labor budget (based on budgeted annual sales): Product G: 8,000 × $16.00=$128,000 Product T:15,000 × $12.00= 180,000 Product W:4,000 × $8.00= 32,000 Total $340,000 Predetermined overhead rate = Budgeted overhead / Budgeted direct labor = 875% Gigabyte’s pricing method has been to set a target price equal to 150 percent of full product cost. However, only the thingamajigs have been selling at their target price. The target and actual current prices for all three products are the following: Product G Product T Product W Product cost .......................................$ 191.00 $169.50 $ 95.50 Target price .............................................286.50 254.25 143.25 Actual current selling price................213.00 254.25 200.00 Gigabyte has been forced to lower the price of gismos in order to get orders. In contrast, Gigabyte has raised the price of whatchamacallits several times, but there has been no apparent loss of sales. Gigabyte, Inc. has been under increasing pressure to reduce the price even further on gismos. In contrast, Gigabyte’s competitors do not seem to be interested in the market for whatchamacallits. Gigabyte apparently has this market to itself. Required: 1. Is product G the company’s least profitable product? 2. Is product W a profitable product for Gigabyte, Inc.? 3. Comment on the reactions of Gigabyte’s competitors to the firm’s pricing strategy. What dangers does Gigabyte, Inc. face? 4. Gigabyte’s controller, Nan O’Second, recently attended a conference at which activity-based costing systems were discussed. She became convinced that such a system would help Gigabyte’s management to understand its product costs better. She got top management’s approval to design an activity-based costing system, and an ABC project team was formed. In stage one of the ABC project, each of the overhead items listed in the overhead budget was placed into its own activity cost pool. Then a cost driver was identified for each activity cost pool. Finally, the ABC project team compiled data showing the percentage of each cost driver that was consumed by each of Gigabyte’s product lines. These data are summarized as follows: Activity Cost Pool Cost Driver Product G Product T Product W Machine setup Number of setups 20% 30% 50% Machinery Machine hours 25% 50% 25% Inspection Number of inspections 15% 45% 40% Material handling Raw-material costs 25% 69% 6% Engineering Number of change orders 35% 10% 55% Show how the controller determined the percentages given above for raw-material costs. (Round to the nearest whole percent.) 5. Develop product costs for the three products on the basis of an activity-based costing system. (Round to the nearest cent.) 6. Calculate a target price for each product, using Gigabyte’s pricing formula. Compare the new tar-get prices with the current actual selling prices and previously reported product costs.
Help on 3, 4 and 5
Gigabyte, Inc. manufactures three products for the computer industry:
Gismos (product G): annual sales, 8,000 units Thingamajigs (product T): annual sales, 15,000 units Whatchamacallits (product W): annual sales, 4,000 units
The company uses a traditional, volume-based product-costing system with manufacturing over-head applied on the basis of direct-labor dollars. The product costs have been computed as follows:
Product G Product T Product W Raw material ..........................$ 35.00 $52.50 $17.50 Direct labor 16(.8 hr.at $20) 12(.6 hr at $20) 8(.4 hr at $20)
Manufacturing overhead* ......140.00 105.00 70.00
Total product cost ..................$191.00 $169.50 $95.50 *Calculation of predetermined overhead rate:
Manufacturing overhead budget:
Machine setup...................................................................................$ 5,250 Machinery.................................................................................................1,225,000
Inspection ....................................................................................................525,000
Material handling.....................................................................................875,000 Engineering ........................................................................................... 344,750
Total ........................................................................................................$2,975,000
Direct-labor budget (based on budgeted annual sales):
Product G: 8,000 × $16.00=$128,000
Product T:15,000 × $12.00= 180,000
Product W:4,000 × $8.00= 32,000
Total $340,000
Predetermined overhead rate = Budgeted overhead / Budgeted direct labor = 875%
Gigabyte’s pricing method has been to set a target price equal to 150 percent of full product cost. However, only the thingamajigs have been selling at their target price. The target and actual current prices for all three products are the following:
Product G Product T Product W
Product cost .......................................$ 191.00 $169.50 $ 95.50
Target price .............................................286.50 254.25 143.25
Actual current selling price................213.00 254.25 200.00
Gigabyte has been forced to lower the price of gismos in order to get orders. In contrast, Gigabyte has raised the price of whatchamacallits several times, but there has been no apparent loss of sales. Gigabyte, Inc. has been under increasing pressure to reduce the price even further on gismos. In contrast, Gigabyte’s competitors do not seem to be interested in the market for whatchamacallits. Gigabyte apparently has this market to itself.
Required:
1. Is product G the company’s least profitable product?
2. Is product W a profitable product for Gigabyte, Inc.?
3. Comment on the reactions of Gigabyte’s competitors to the firm’s pricing strategy. What dangers does Gigabyte, Inc. face?
4. Gigabyte’s controller, Nan O’Second, recently attended a conference at which activity-based costing systems were discussed. She became convinced that such a system would help Gigabyte’s management to understand its product costs better. She got top management’s approval to design an activity-based costing system, and an ABC project team was formed. In stage one of the ABC project, each of the overhead items listed in the overhead budget was placed into its own activity cost pool. Then a cost driver was identified for each activity cost pool. Finally, the ABC project team compiled data showing the percentage of each cost driver that was consumed by each of Gigabyte’s product lines. These data are summarized as follows:
Activity Cost Pool Cost Driver Product G Product T Product W Machine setup Number of setups 20% 30% 50%
Machinery Machine hours 25% 50% 25%
Inspection Number of inspections 15% 45% 40%
Material handling Raw-material costs 25% 69% 6%
Engineering Number of change orders 35% 10% 55%
Show how the controller determined the percentages given above for raw-material costs. (Round to the nearest whole percent.)
5. Develop product costs for the three products on the basis of an activity-based costing system. (Round to the nearest cent.)
6. Calculate a target price for each product, using Gigabyte’s pricing formula. Compare the new tar-get prices with the current actual selling prices and previously reported product costs.
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