Objective: Demonstrate understanding of Activity-based Costing analysis and managerial application Background: Mr. Stanley Stephens, Plant Controller at the Bedford Manufacturing plant overseas the...

Objective:
Demonstrate understanding of Activity-based Costing analysis and managerial application

Background:

Mr. Stanley Stephens, Plant Controller at the Bedford Manufacturing plant overseas the manufacturing and sales of Fuel Pressure Regulators. Fuel Pressure Regulators are a relatively small but essential engine component that meters the pressure of fuel entering the engine’s fuel rail and through the fuel rail, the combustion cylinders.

Currently, over 90% of customers’ orders are for a standard model of fuel pressure regulator. However, there has recently been an increase in demand for customized models, with fuel inlet and outlet tubes that are bent at various angles.

Although Mr. Stephens wants very much to accommodate customers’ wishes, he recognizes that the customized models create a challenge for his manufacturing team. The plant recently invested significant capital into automating the production of the standard fuel pressure regulator model, enabling the manufacturing team to produce a high volume of standard regulators at a low unit cost. The custom models can utilize a small portion of the high-volume automated machinery, and then must be taken off “the line” for custom assembly processes using small tools and inexpensive machinery.

Currently, the team calculates unit product costs by allocating manufacturing overhead costs as a proportion of direct labor dollars. The standard regulator requires very little direct labor in its assembly. The custom models, on the other hand, require a lot more direct labor. Manufacturing overhead is currently allocated to each regulator using the same direct labor hour-based rate. Mr. Stephens has a stack of new orders for custom regulators waiting to be evaluated but is concerned about the products’ financial viability. He feels that something is not quite right in his calculations, so he has engaged you to revisit his product costing process using activity-based costing procedures.

In advance, in consultation with his manufacturing team, Mr. Stephens has calculated manufacturing overhead cost pools and decided on cost drivers for each cost pool. He is asking you for the following:

Deliverables:

1. Calculate Activity Cost Pools for each activity.
   
   
   • Explain how each cost pool can be interpreted in terms of how costly each overhead activity is.
   
   
   
   


2. Calculate Activity Rates for each manufacturing overhead cost pool.
   
   
   • Explain how each rate can be interpreted in terms of how costly each manufacturing overhead activity is.
   
   
   • Comment on the strengths and weaknesses of Mr. Stephens’ selection of cost drivers. Identify several theoretical alternatives, and comment on their validity.
   
   
   
   


3. Using the direct labor hour-based manufacturing overhead rate to calculate and assess the profitability of each product line.


4. Using the Activity Rates you derive above using Mr. Stephens’ cost drivers, re-calculate the average unit product margin for the Custom Design and Standard Design fuel pressure regulators.
   
   
   • Compare the unit product margins using activity-based costing with those calculated using the status quo method. Comment on the accuracy of each estimate.
   
   
   • Which method would you recommend Mr. Stephens use for establishing a selling price for new orders? Why?
   
   
   • Strategically, comment on whether Mr. Stephens should promote the sales of Custom Designs or Standard Design fuel pressure regulators. Explain your rationale.