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Length: 1,500 words maximum

Please note that this is a group assignment and each group will have five students. Groups larger or smaller than this will only be permitted in very exceptional circumstances.

Case title: FTG Ltd

Read the case study and answer the following questions. You need to show all your workings in table format whenever applicable. Identify clearly the question number that your answer is related to. Marks will be deducted for poorly set out or unclear presentation. Please print on one side of the paper only and use a font size of 12 and insert page numbers. Please use Word tables and not Excel worksheets.
  1. What is the reported unit cost of product C300 under:
    1. The existing standard costing system? (5 marks)
    2. A multi-rate system where each manufacturing department has its own overhead rate and all other overhead (i.e. support department costs) is allocated using direct labour dollars? (6 marks)
    3. The new activity-based system designed by Anne Abbot? (14 marks)
  2. Analyse the activity-based system designed by Anne Abbott:
    1. What are its strengths and weaknesses? (12 marks)
    2. What changes would you make to it and why? (8 marks)
  3. Would you recommend that FTG Ltd implement the activity-based cost system (after making any modifications you recommended in your answer to question 2)? Justify your recommendation. (5 marks)
  4. What is the approximate profit differential between pricing the C300 at $90 and $80 (assume that the marketing sales estimates are correct, i.e. the firm will sell 50,000 units at $90 and 70,000 at $80):
    1. Using the current absorption costing approach. (3 marks)
    2. Using a variable costing approach. (5 marks)
    3. Using an ABC approach. (7 marks)
  5. What price would you recommend for the C300?  Explain your recommendation. (5 marks)

Case study — FTG Ltd

The new C300 is currently budgeted to sell through the mass merchandiser chains for about $150 retail.  I think this price is too high.  We will only sell about 50,000 units a year at that price. I think we should drop our selling price from $90 to $80, and allow the merchandisers to drop their retail price to just under $135. At that price we should sell at least 40% more units, and since the variable cost is about $50, our overall profits will be higher.


I`m not sure we really know what our products cost. I would like to really make certain that we are making a profit at $80 before I agree to drop our price, because we will not be able to change prices again in the near future.

The FTG Ltd a Victorian manufacturer of fireproof home and office safes, was founded in 1931 to produce insulated metal office safes.  Over the years, additional metal products, including containers, files, and smaller safes, were introduced. Many of these products were aimed at the consumer as opposed to the office market. In 1994, a completely new class of products manufactured out of plastic was introduced. Due to their ease of manufacture and low cost, the plastic products made household record protection possible and practical. By 1998, these products had considerably expanded the consumer market.
In 2012, FTG had total revenues of close to $100 million generating net income in excess of $5 million (see Exhibit 1).  The Company is now run by Jack and Dick Brush, sons of the company’s founder, John D. Brush, Sr., while their younger brother, Bob, runs the distribution centres. Jack’s sons, Doug and Jim, are the marketing and sales managers, respectively.

Product description
FTG manufactures over 50 different models in eight product lines - seven metal, and one plastic.  Within a product line, the various models differ only in size. Different models from the same product line can be produced in a single batch without incurring any additional costs.  The only real difference is the time taken to weld and fill the insulation cavity. The eight product lines are as follows:

Metal products
  1. Standard safes include 14 models, each approximately 2 feet tall and 1.5 feet wide, with varying depths.  FTG uses 20-gauge cold-rolled steel to make these products. The safes are certified by the Underwriters Laboratory (UL) to withstand the heat from a house fire (1,500 Degrees Fahrenheit) for two hours. This certification is called a ‘two-hour UL rating’.
  2. Design ‘82 is a slightly higher quality line of safes.  These safes provide improved capacity and security. There are seven models in this product line. These safes are 4 inches taller and 2 inches wider than the standard safes and have four active, live-bolt security locks rather than one. These safes also have a two-hour UL fire rating.
  3. Large safes are the company’s largest capacity safes and are almost 3 feet high and 2 feet wide.  They are purchased mainly by businesses and carry a two-hour UL fire rating. There are four models in this line.
  4. Small safes are smaller and lighter versions of the safe line. These products are made from 24-gauge steel and only carry a one-hour UL fire rating. There are two 11 inch x 13 inch models. These are about 5 inches shorter and 3 inches narrower than the standard safes but have the same depth.  The three box models are similar in height and width to the 11 x 13 but are shallower.
  5. Files are single-drawer pull-out units. The files are 14 inches tall, 16 inches wide, and vary in depth from 24 to 30 inches.  They are made of lighter-weight steel similar to the small safes and have a one-hour fire rating. FTG sells four different types of files.
  6. Media safes are new products introduced to provide protection for personal computer data (CDs and USBs). There are two models in the media family which are produced by placing an additional insulated box inside the two most popular models of standard safe. The additional insulation keeps the internal temperature of these safes sufficiently low so that the media is not damaged.  Media products have a two-hour (UL) fire rating.
  7. Security safes consist of two types of products, Pipes and S-4s.  They are a very old product line and are not insulated for fire protection and therefore are used solely for security purposes. The Pipes are circular, in-floor safes which can be installed in either wood or concrete. The S-4s are a rectangular wall safe. There are seven different models in this product line.
Plastic products
  1. Plastic products were introduced in late 1994 and quickly became the firm’s highest-volume products. These are injection moulded top-opening chests which can hold letter-size hanging file folders. There are seven models of plastic products and they have a half-hour UL fire rating.
Competitive environment
FTG markets its products as being the highest-quality available. The company offers a three-year warranty on parts and service and a 10-year replacement warranty if the safe is damaged in a fire.  FTG competes in two distinct markets with its metal and plastic products: mass merchandisers and office products dealers. Mass merchandisers are the high-volume retail outlets (like K-Mart) who sell directly to the public. Because they promote the products heavily, they are concerned mainly with getting the best price and sufficient quantity to guard against stock-outs. The office products dealers are less concerned about price than they are about having a full high-quality product line.  Sales of the metal product lines are split 60% to mass merchandisers and 40% to office products dealers, while 80% of the plastic products are sold to mass merchandisers and 20% to office products dealers.  The cost of doing business in the two markets is very similar. The only real differences are the cost of cooperative advertising (about 6% in the mass merchandising market and 1% in the office products) and freight charges (the office products distributors pay all of their own freight charges).
Metal products. The market for the insulated metal home and office safes is approximately $160 million per annum at retail, with overall growth expected to be 10% per annum.  FTG is the leader in this market with an approximate 50% share. There are three major domestic competitors accounting for about 10% each and three foreign competitors that together account for 20%. The domestic competitors offered similar products to FTG but at slightly higher prices. These companies are larger, full-line safe manufacturers who offer large, commercial-purpose safes as well as smaller home and office ones. The foreign competitors offered products of slightly lower quality at a much lower price.
Plastic products.  FTG’s recent victory in a patent infringement lawsuit has forced two foreign competitors to stop producing imitations of FTG’s plastic product line.  This victory left FTG as the sole producer of this type of product.  With over 10 years left on the patent, it does not look like competitors will be able to produce similar products in the near future. The plastic products compete with the traditional residential fire protection storage boxes. These are small metal boxes that are insulated with gypsum, a much less effective insulation material than the vermiculite used in the plastic products.  The market for residential fire protection boxes is estimated at $100 million retail, with an overall growth of 15% per annum. This market is highly fragmented with many small competitors selling gypsum products.

Production process
FTG’s corporate headquarters and production facility is located in a 250,000-square-foot building in Geelong, Victoria.  The production and inventory storage areas occupy about 80% of the total space available.
Metal products.  FTG manufactures in-house the majority of the steel parts for the metal safes.  Production starts in the Press Department, where cold-rolled steel is cut to the proper length and width on shear presses.  Large presses are used to form the inner and outer steel jacket parts, doors, and door jambs.  The door jambs and frames are spot welded to add strength and to create a smoother appearance, while the door hinges are Mig welded to add durability.
When all welding is finished, the safe frame and door are filled separately with vermiculite insulation (a mixture of water, chemicals, and cement) and set aside to cure for approximately 24 hours.  When the insulation is dry, the safe pieces are cleaned and painted and hung on a large overhead conveyor, which travels slowly around the factory, to dry. By the time they reach the final assembly area, the pieces are dry and the safe frame, door, and lock are assembled to form the completed safe.  The completed safe is then packed for shipment.
Plastic products.  FTG subcontracts production of the plastic chests and lids.  The two pieces are received, inspected, and moved to the Insulation Department, where they are filled with vermiculite and set aside to cure.  Since the plastic products do not need to be painted, they are moved directly from the Insulation Department to the Plastic Assembly Department, where the chest body, lid, and lock are assembled and the completed chest is packaged for shipment.

Cost accounting system
FTG uses a standard product costing system to account for inventory transactions throughout the year. The material and labour standards are reviewed annually and updated as needed. The overhead allocation calculation is made at the end of every fiscal year, and the result is used in the next year’s standard costs.
The material portion of the standard costs is calculated by multiplying the standard material content of the products by the standard price per unit for each type of material used.  The labour portion of the standard cost is calculated by summing the standard hours per unit for each direct department and multiplying the result by the company’s average labour rate of $18.00 per hour (Exhibit 2 contains the standard hours per unit by manufacturing department for representative products in each product line).
There are seven manufacturing departments (Press, Spot Welding, MIG Welding, Insulation, Clean and Paint, Metal Assembly, and Plastic Assembly). The labour accounts for these direct manufacturing departments include both direct and indirect labour; for example, materials handling is included in the labour accounts. To determine the direct labour content of the products, the Controller’s Department calculates the annual percentage of indirect versus direct hours for the entire plant from the payroll records.  It then takes the indirect percentage out of the labour figures to give the direct labour standards.  In 2011 the average indirect percentage was 22%; consequently, this rate was used in setting the 2012 standards. The indirect labour costs identified by this procedure were called ‘allocated indirect labour’ and treated as part of production department overhead.
Overhead contains five major elements: allocated indirect labour, the overhead associated with the seven manufacturing departments, general plant office costs, shipping and receiving costs, and maintenance costs.  The overhead rate for the year is determined by dividing the total overhead of the previous year by the total direct labour costs (Exhibit 3).  The resulting overhead rate is multiplied by the direct labour content of the products to give the overhead cost per product. The cost system does not formally differentiate between variable and fixed costs, but the Controller estimates that 75% of production costs were variable.
The costs of all other departments, including Engineering, Quality Control, and Materials Management, are considered period expenses and are included in selling, general, and administrative expenses (Exhibit 4 contains the 2011 manufacturing department summary cost report, Exhibit 5 the 2011 support department summary cost report, and Exhibit 6 the 2011 cost report for the selling, general, and administrative departments).

The product costing analysis
Dick Legge, Manager of Special Projects, joined the company in 1992 after running his own management consulting firm for about 25 years. Dick had recently attended a seminar on competing through manufacturing at Deakin University. One of the speakers had outlined how traditional cost accounting systems that allocate indirect and support costs on the basis of direct labour could significantly misstate product costs. This speaker had increased Dick’s misgivings about his firm’s cost system. When he heard Jack Brush’s concern about the accuracy of the reported product costs, Dick agreed wholeheartedly and was asked to undertake a special study to determine more accurate product costs.
Dick commented,

I am not a specialist in cost system design and did not feel equipped to undertake the study on my own.  Consequently, I hired a consulting firm to undertake the analysis. The launch date of the new C300 product was only three months away, so they were given 10 weeks to make a more accurate determination of product costs.

The consulting firm sent Anne Abbot, a recent MBA graduate and CPA, to design the system. She first studied the validity of the direct material and direct labour accounting systems. Satisfied that these systems were relatively accurate, her major concern was the accuracy of the allocated indirect labour, but because she could see no way in the short term to improve the situation, she turned her attention to the overhead accounts. Anne started with the manufacturing department overhead costs.  These costs amounted to just under $2.7 million.
The general ledger had recently been reorganized to allow the manufacturing overhead costs to be traced to the departments. Anne reviewed the tracing procedures and decided that the departmental costs were adequate for her purposes. Discussions with plant personnel indicated that these costs could be allocated to the product lines using direct labour hours and then to the products by the number of units produced.
The technique of tracing costs first to the product line and then to the products using the number of units produced was acceptable because of the similarity in the manufacturing processes for products in the same product lines. From an overhead perspective, the products within each line were essentially identical.  Therefore, they should have the same overhead traced to them. Using the number of units produced achieved this objective.
The next costs Abbot analysed were those of the three support departments. The cost of these departments amounted to just under $9 million (see Exhibit 5). The General Plant Office was the largest of the three, with annual costs of about $7.5 million. Anne asked Roger Murphy, the Office Manager, about the activities that drove these costs. He said that the expenses in the General Plant Office category were caused by a number of different factors. The amount of supervisory time spent on a specific product or product line varied depending according to the number of direct labour personnel in the department, the complexity of the products produced, and the skill level of the department’s employees. Utilities Expense was most closely related to the amount of time machines were running each day in a given department, while the cost of uniforms was determined by the number of people working in a department. The depreciation on certain machines and equipment could be traced to the departments in which the machines were located. The rest of the costs were small and not driven by any particular activity. Abbot analysed the General Plant Office costs into five categories that were identified by Murphy.
For each of these categories, Abbot identified an allocation base to trace the costs to the cost centres. These bases were as follows:
Cost category Allocation base
SupervisionDirect tracing
UtilitiesManagement estimate
UniformsHead count
Item depreciationDirect tracing
OtherManufacturing square feet
Sue Merz, Supervisor of the Shipping and Receiving Department, said that the title of the department should actually be Materials Handling. She identified her department’s activities as being 30% shipping, 25% receiving, and 45% material requisitions. Lynn Barber, Manager of the Maintenance Department, said that it is easy to identify what keeps her people busy because normal, preventive, and emergency maintenance is performed on the basis of work orders issued. Abbot identified the cost drivers of the activities for these two departments as follows:
ActivityCost driver
ShippingBills of lading
Materials requisitionRequisitions
MaintenanceWork orders
Abbot then turned her attention to the selling, general, and administrative accounts. She was concerned that many of the costs contained in these accounts were actually production costs. She interviewed the supervisors of the quality control, materials management, and engineering departments to see if she was right. Her suspicions were borne out by the interviews. John Martin, the Quality Control Supervisor, confirmed that 100% of his department’s efforts were related to production. He said that 40% of the department’s time is spent on statistical process control, and 60% related to inspection activities. In general, he feels that the amount of time spent on process control is determined by the number of times the product was manufactured. Inspection activity is also driven by production runs because the Quality Control Department examines the first and last items in each production run.
Wayne Kokinda, the Materials Manager, is responsible for overall management of purchasing and inventory scheduling. Wayne said that 70% of the total cost of the Materials Management Department relates to purchasing, while the other 30% is related to inventory scheduling. He suggested that Abbot interview the individuals in charge of those two areas, Terry Marlowe and Paul Bovard. Marlowe, the Purchasing Manager, said that the work performed in the department was driven by the number of purchase orders it issued. Bovard, the inventory and production scheduler, said that his work is divided between preparing the master production schedule, expediting important orders, and updating the master data files. While not able to identify easily measured cost drivers, he was able to estimate the time spent in his department on each product line.
Mark Preston, Engineering Department Manager, stated, ‘Our time is divided almost evenly between developing new products and modifying existing products and production processes’. The work performed on existing designs or processes is initiated by engineering change orders and can therefore be traced to specific products or product lines.
Finally, the costs of the General Corporate Department are related to the entire building. These costs included building depreciation, property taxes, and building and grounds.
From these interviews Anne Abbot chose the following cost drivers for the activities performed in these departments:
ActivityCost driver
Quality controlProduction runs
PurchasingPurchase orders
Inventory schedulingTime estimated
Engineering (current portion only)Engineering change orders
Corporate (building)Total square feet
Using total square feet as an allocation base caused some of the building costs to be traced to the inventory storage and administrative areas of the facility.  Abbot allocated the costs traced to the inventory storage areas using percentage of sales, which she felt was an adequate proxy for the area dedicated to each product line.  The costs traced to the administrative areas she redefined as selling, general, and administrative costs.  The costs transferred from the sales, general, and administrative category amounted to about $3.5 million (see Exhibit 7). This transfer increased manufacturing overhead to about $17.5 million.
After completing the interviews and identifying the cost drivers, Abbot set about collecting the quantity of each cost driver associated with every product line. This process took about four weeks to complete, and from this data Abbot was able to compute the cost per activity unit (Exhibit 8).
To demonstrate the impact of the conversion to activity-based costing, Abbot generated a comparison of the old and new costs for the highest sales dollar model in each product line (Exhibit 9). Abbot then turned her attention to the C300, the product that had initiated the study.

The C300 decision
The C300 was a new product that the firm planned to introduce in June. It was a plastic chest that could hold 12 file folders, twice the capacity of the largest existing product, the C200. The C300 represented a minor technical breakthrough because of its size. A special way to fill the insulation cavity had to be developed. This process was currently being patented. This patent would increase the firm’s hold on the manufacturing technology of plastic products. The people at FTG are excited about its new product, which they feel would rapidly become a best seller.
Abbot, after working with the design and manufacturing engineers, was able to estimate the activity-based parameters for the new product (Exhibit 10).  Her major concern, as she sat down to estimate the activity-based cost of the C300, was what price she would recommend for the C300 if she were asked her opinion at the upcoming presentation of her study findings.

Question Set #29

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