Sutcliffe Electronics

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Sutcliffe Electronics

1. 1.

Sutcliffe Electronics should not stress on the Maximum model and should not cut down the Mammoth model. Under activity-based costing, the Maximum model has an operating profit margin of less than 3%, while the Mammoth model has an operating profit margin of approximately 43% as shown in calculations.

Cost driver rates for the various activities recognized in the activity-based costing (ABC) system are as follows:

Sutcliffe Electronics

Cost of Each Model under Activity Based Costing

Profitability Breakdown

Per unit calculation

Units sold                                   22,000                          4,000

Selling price per unit

($21,780,000 ¸ 22,000;

$5,016,000 ¸ 4,000)                     $990.00                    $1,254.00

Cost of goods sold

($12,430,110 ¸ 22,000;

$4,875,090 ¸ 4,000)                       (565.01)                        (1,218.77)

Gross Profit                                    $424.99                            $ 35.23

Gross profit margin ratio                  42.9%                                2.8%

2. 2.

Sutcliffe Electronics’ costing system (simple) apportions all manufacturing overhead other than machine costs based on machine-hours, and output unit-level cost driver. Thus, the more machine-hours per unit that a product requires, the more the manufacturing overhead apportioned to it. Since Mammoth uses twice the machine-hours per unit compared to Maximum, a higher amount of manufacturing overhead is allocated to Mammoth. The ABC analysis identifies several batch-level cost drivers, such as purchase orders, shipments, and setups. Maximum uses these resources much more intensively than Mammoth. The ABC analysis further identifies Maximum use of these overhead resources. Consider, for instance, purchase order costs.

The simple system allocates these costs based on machine-hours. As a result, each unit of Mammoth is allocated twice the purchase order costs of each unit of Maximum. The ABC system allocates $440,550 of purchase order costs to Mammoth (equal to $20.02 [$440,550 ¸ 22,000] per unit) and $604,890 of purchase order costs to Maximum (equal to $151.23 [$604,890 ¸ 4,000] per unit). Each unit of Maximum uses 8.31 ($151.23 ¸ $20.02) times the purchases order costs of each unit of Mammoth. It is recognizing Maximum‘s more exhaustive use of manufacturing overhead results in Maximum showing much lower profitability under the ABC system. By the same demonstration, the ABC analysis shows that Mammoth is more profitable. The simple costing system over disadvantaged Mammoth and made it appear less profitable.

3. 3.

Epstein‘s comments about ABC implementation are useful. When crafting and executing ABC systems, top managers and management accountants need to trade off the costs of the system against the payoffs. More activities tend to make any system complicated and more costly to implement. However, it can probably improve the accuracy of cost information, and this will help Sutcliffe Electronics make sound decisions. Likewise, using inspection hours and setup-hours as allocation bases would also probably lead to more accurate cost information, but it would increase measurement costs.

Q.4.

Information from activity-based costing can be used to make positive changes in an entity. For example, an object could review product prices informed by the reviewed cost information. For the long term, activity-based costing can assist management in making decisions regarding the feasibility of product lines, distribution channels, marketing strategies, and expansion strategies. It highlights possible improvements, including reduction or elimination of activities that do not add value, choosing cost-effective activities, cost-sharing activities with other products, and avoiding waste. ABC information is a unified approach that concentrates management‘s attention on activities with the definitive aim of constant improvement. As an entity at large, ABC information emphases on tactical, as well as strategic and operational activities of the company

5. 5.

Incorrect reporting of ABC costs to retain both the Mammoth and Maximum product lines is unbecoming and unethical. In analyzing the problem, some of the ethical standards of management accountants are listed below:

Competence

Clear reports using relevant and reliable information should be prepared. Preparing reports based on incorrect costs to retain product lines violates competence standards. It is unethical for Colin Hanton’s to change the ABC system with the malicious goal of reporting different product cost numbers that Epstein favours.

Integrity

The management accountant has a responsibility to avoid or reveal conflicts of interest and advise all interested parties of any potential conflict. Colin Hanton’s may be tempted to change the product cost numbers to appeal Epstein, the division head. This would undermine the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate right as well as wrong information. Colin Hanton’s ought to specify to Epstein that the product cost computations are, undoubtedly, right. If Epstein still insists on changing the product cost numbers, Colin Hanton’s flag the matter to Epstein’s seniors. If, after taking all these steps and there is no change, then he can consider resigning from the company.