Individual Assignment 1Hindenburg Inc. is a manufacturing compnay in the city of New Orleans, Louisiana that specializes
in farm-related equipment, such as tillers, etc. They have two types of tillers – Standard and
Custom. Despite steady demand, company president, Mr. Adani, is concerned about losses the
company is incurring for Standard tillers. He wants to raise the prices of Standard tiller but is
worried since the competition in the segment is high and he needs to keep the prices in line with
his competitors. He is happy with the profits from the custom tillers and wants to undertake more
custom orders and wants to reduce prices to get more orders in this segment.
Before taking any of these pricing decisions, while he believes his costing system is correct, he is
somewhat concerned that some overhead costs are not allocated properly across two types of
equipment. He is currently using traditional costing methodology based on direct labor hours to
estimate manufacturing overheads for each tiller.
Mr. Adani has hired a recently designated CPA to help him solve the dilemma. The CPA has
decided to implement an activity-based costing system designed to provide relevant information
to assist with decision making. The ABC system she designed has three activity cost pools: Order
processing costs, machine processing costs, and product inspection costs. These activities are
driven by number of orders processed (Order processing activity), machine hours worked
(Machine processing costs), and inspection hours (Product inspection costs).
The following actual costs will be assigned using the activity-based costing system:
Order processing costs
Machine processing costs
Product inspection costs
Total manufacturing overheads
$520,000
$1,960,000
$620,000
$3,100,000
To get started the CPA has asked that she review the sales figures and other relevant information
about two models of tillers (standard and custom). The information related to the tillers is as
follows:
Annual Sales
Sales Price ($ per unit)
Direct Labor Hours (per unit)
Direct Labor Rate per Hour
Direct Materials ($ per unit)
Orders processed
Machine hours worked
Inspection hours
Standard Tiller
3,000 units
$900
5
$30
$300
300
27,000
3,000
Custom Tiller
4,000 units
$1,250
4
$30
$500
1,000
43,000
9,400
Required:
1. Assuming use of direct labor hours as cost driver, compute the unit manufacturing cost
and the per unit gross profit of the standard and custom tillers.
2. Assuming use of activity-based costing, compute the unit manufacturing cost of the and
the per unit gross profit of standard and custom tillers.
3. Which of the cost estimates in (1) and (2) is likely to be closer to the “true” costs of
manufacturing the two types of tillers?
.
4. Calculate the amount of cost-distortion based on traditional costing and activity-based
costing and explain the reasons for incurred losses for Standard tiller earlier.
5. What do you think would have happened to the actual sales of the two types of tillers if,
say, Mr. Adani had increased the selling price of Standard tiller by $100 and reduced the
price of Custom tiller by $50? And to the overall profits of Hindenburg, Inc?
6. Overall, what are your conclusions about using product cost information from traditional
costing systems for pricing purposes in competitive markets?
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