Schedule 1

Pilgrims Manufacturing, Inc.: Activity-Based Costing Versus Volume-Based Costing

Pilgrims Manufacturing, Inc. manufactures cooling and heating coils for several different industries. It has two plants, Jewett City Plant (JCP) is an older, labor intensive machine shop where skilled workers use tools to perform most of the work. Greenwich Plant (GP) is highly automated and uses computer numerically controlled (CNC) machines with a small number of highly paid workers. JCP manufactures a high tolerance coil (Pa) and finishes a second one (Pb). GP mass produces two standard coils, Pc and Pd, and performs basic operations on Pb before transferring it to JCP for finishing. Production takes place in batches. Each batch is made of one product.

The products are sold directly to manufacturers by a technical sales force. Product Pa is a customized product manufactured to order, and requires a lot of specifications and negotiation with customers. Product Pb is a modification of the standardized products Pc and Pd. It is finished to meet each customer’s specifications, and as a result has more exacting technical specifications than Pc and Pd, and is hence finished in JCP. Products Pc and Pd are standardized products produced for stock and sold off-the-shelf and do not require much sales effort in writing up orders.

Each plant has six production and service departments, receiving, cutting & assembly, heat treatment, testing, packing & shipping, and repairs & maintenance (Charts 2 and 3). Exhibit 1 includes descriptions of activities in each of these departments. In addition, there are three departments -- marketing, design & engineering support, and administration -- at the corporate level (Chart 4).

The present accounting system is a traditional financial reporting driven system. Manufacturing costs are classified as material, labor, and overhead. Overhead is charged to products based on labor hours with the two plants treated as one cost center. Marketing, design & engineering support, and administration are considered period costs and not charged to products.

The President of the Company held a meeting with senior executives including VP-Finance, VP-Manufacturing, and VP-Marketing (Chart 1) to discuss the 2006 budget (Schedules 1, 2, and 3). She was unhappy with the fact that Pa´s budgeted price of $45 is below its standard cost of $48.29. However, she was not sure if the costing system, which treats both plants as one cost center, accurately determines the costs of the different products. She pointed out that GP is a machine intensive plant while JCP is more labor intensive. Furthermore, the products are produced in different numbers of batches (Schedule 6), and affect batch-related costs (e.g. testing and heat treatment) differently. She told VP-Finance that she has heard of an alternative costing method that uses multiple cost centers/pools and different cost bases to charge indirect costs to products. She also questioned the treatment of technical support costs and marketing expenses as period costs. VP-Finance promised to investigate the President’s points and report back to the group.

Required:

The VP-Finance appointed you as a team to investigate the President’s concerns. He suggested that you develop and compare several volume-based costing and activity-based costing (ABC) systems to identify and recommend the system that you deem to give the most accurate product costs.
For the traditional volume-based systems use the Overhead Allocation Menu shown at the bottom of the case to perform the following tasks:
1. Use machine hours, instead of direct labor hours, to allocate manufacturing overhead to the four products and restate the Products Budget (Schedule 1).
2. Repeat requirement 1, assuming that each plant is a separate cost center, and direct labor hours are used to allocate manufacturing overhead in both plants. Schedule 4 reports the labor hours per unit for each product.
3. Repeat requirement 2, assuming that labor hours are used to allocate manufacturing overhead in JCP and machine hours in GP. Schedule 5 reports the machine hours per unit for each product in the two plants.
4. Use an activity-based costing system to calculate new costs and profitability of each of the four products (Schedule 1) under the system.

To design the ABC systems you have visited the two plants where you interviewed plant managers, department supervisors and accountants. You also analyzed expense accounts and operations data. Based on the interviews and analyses, your team prepared descriptions of activities within each of the departments in each plant (Exhibit 1). You also decided to create plant-sustaining cost pool to which you allocated factory costs that you decided couldn’t accurately be allocated to the other departments. Finally, you prepared an analysis and description of the costs in each cost pool (Exhibit 2). And allocated the costs of the eight cost pools as shown in Schedule 9 to the different departments and to the plant-sustaining cost pool. To complete the design of the ABC system you have to make decisions on the following:
a. Which cost driver to use for allocating the costs of each activity to each of the products? Schedules 4-5 present labor hours and machine hours per unit for each product. Schedule 6 lists the number of batches for each product. Schedule 1 lists the number of units for each product.
b. Should you charge the design & engineering support and marketing expenses to products or treat them as firmwide costs? Schedules 7-8 present sales personnel time distribution, and design & engineering support time distribution. If you decide to treat design & engineering and marketing as product costs, use the Overhead Allocation Menu to select the cost drivers and charge the cost to the products.
5. Write a report to the President that includes your analysis in Requirements 1-4, and state which of the four you recommend and why.
6. (Optional). Create a worksheet and use the information provided in schedules 1-12 to allocate the overhead costs to the activities (Schedule 12 lists the costs, activities and rates). Select cost drivers to allocate the activities to the products and use that to prepare Schedule 1 Product Budget.

Schedule 1 2004 Products Budget
	Pa	Pb	Pc	Pd	Total
Units	70000	100000	500000	1000000
Price^a	$45	$30	$4	$5
Standard Costs (Schedule 3)	$48.29	$19.11	$2.45	$2.45

Revenue	$3,150,000	$3,000,000	$2,000,000	$5,000,000	$13,150,000
Manufacturing costs:
Direct materials	$84,000	$120,000	$600,000	$1,200,000	$2,004,000
Direct labor	$840,000	$458,750	$243,750	$487,500	$2,030,000
Manufacturing overhead	$2,470,000	$1,323,214	$382,262	$764,524	$4,940,000
Total manufacturing costs	$3,394,000	$1,901,964	$1,226,012	$2,452,024	$8,974,000
Gross Margin	($244,000)	$1,098,036	$773,988	$2,547,976	$4,176,000
Less common costs:
Design & engineering costs					$500,000
Marketing & sales expenses					$960,000
G&A					$650,000
Total Costs					$2,110,000
Net profit					$2,066,000
^a Average estimated prices.

Schedule 2 2004 Financial Budget
	JCP	GP	Total
Sales			$13,150,000
Products costs:
Direct materials	$104,000	$1,900,000	$2,004,000
Direct labor	1,280,000	750,000	2,030,000
Manufacturing overhead:
Power & heat	160,000	270,000	430,000
Repair & maintenance	150,000	300,000	450,000
Factory expenses	75,000	125,000	200,000
Factory support	400,000	350,000	750,000
Inspection costs	110,000	150,000	260,000
Chemicals & fuel	450,000	1,200,000	1,650,000
Depreciation-equipment	200,000	600,000	800,000
Depreciation-buildings	150,000	250,000	400,000
Total manufacturing overhead	1,695,000	3,245,000	4,940,000
Total manufacturing costs	$3,079,000	$5,895,000	$8,974,000
Gross margin			$4,176,000
Operating expenses:
Design & engineering costs			500,000
Marketing & sales expenses			960,000
G & A			650,000
Total operating expenses			2,110,000
Net profit			$2,066,000
^a Direct labor hours: JCP 32,000 hours @ $40 average hourly rate; GP 10,000 hours @ $75 average hourly rate.

Schedule 3 Unit Standard Cost
	Pa	Pb	Pc	Pc
Direct materials^b	$1.200	$1.200	$1.200	$1.200
Direct labor ^b	12.000	4.5875	0.488	0.488
Overhead ^a	35.285	13.232	0.765	0.765
Total	48.486	19.019	2.453	2.453
^aOverhead rate = $4,940,000¸42,000 hours = $117.62 per direct labor hour. ^bAverage estimated costs.

Schedule 4 Labor Hours Per Unit of Product
Plant	Pa	Pb	Pc	Pd
JCP	0.3 hours	0.11 hours
GP		.0025 hours	.0065 hours	.0065 hours

Schedule 5 Machine Hours per Unit of Product
Plant	Pa	Pb	Pc	Pd
JCP	0.06	0.022
GP		0.05	0.1	0.075

Schedule 6 Number of Batches
Plant/Product	Pa	Pb	Pc	Pd
JCP	10	5
GP		2	2	4

Schedule 7 Marketing & Sales Time Distribution *
Pa	Pb	Pc	Pd
35%	20%	15%	15%
*15% is not spent on any one product.

Schedule 8

Design & Engineering Time Distribution

Basic R&D

35%

20%

10%

25%

Schedule 9

Allocation of Costs to Departments and Activities

Jewett City (JCP):
Expenses		Receiving	Cutting & Assembly	Heat Treat.	Testing	Pack. & ship.	Plant Sustaining
Power	160000	10000	60000	20000	35000	15000	20000
Repairs	150000	15000	55000	18000	40000	10000	12000
Factory Expenses	75000	0	0	0	0	0	75000
Factory Support	400000	0	0	0	0	0	400000
Inspection	110000	0	0	0	0	0	110000
Chemicals & fuel	450000	0	0	450000	0	0	0
Deprec-Equip	200000	20000	50000	60000	50000	10000	10000
Deprec-Bldg	150000	0	0	0	0	0	150000
Total Overhead	1695000	45000	165000	548000	125000	35000	777000
Labor Hours	32000	2000	18000	3000	3000	6000
Machine Hours	6400		5600		800

Greenwich (GP):
Expenses		Receiving	Cutting, Machining & Assembly	Heat treat.	Testing	Pack. & ship.	Plant Sustaining
Power	270000	25000	120000	15000	70000	20000	20000
Repairs	300000	30000	160000	20000	50000	20000	20000
Factory Expenses	125000	0	0	0	0	0	125000
Factory Support	350000	0	0	0	0	0	350000
Inspection	150000	0	0	0	0	0	150000
Chemicals & fuel	1200000	0	0	1200000	0	0	0
Deprec-Equip	600000	35000	250000	80000	200000	25000	10000
Deprec-Bldg	250000	0	0	0	0	0	250000
Total Overhead	3245000	90000	530000	1315000	320000	65000	925000
Labor Hours	10000	3000	3000	1000	1000	2000
Machine Hours	130000		90000		20000	20000

Schedule 10 Labor and Machine Hours Per Department
Jewett City:
	Receiving	Cutting & Assembly	Heat Treat	Testing	Packing & Shipping
Labor Hours	2000	18000	3000	3000	6000
Machine Hours		5600		800

Greenwich:
	Receiving	Cutting & Assembly	Heat Treat	Testing	Packing & Shipping
Labor Hours	3000	3000	1000	1000	2000
Machine Hours		90000		20000	20000

Schedule 11 Departmental Labor & Machine Hours per Product
Jewett City:
	Receiving	Cutting & Assembly	Heat Treat.	Testing	Pack. & shipping	Total
Labor hours	2000	18000	3000	3000	6000	32000
Pa	1312.5	11812.5	1968.75	1968.75	3937.5	21000
Pb	687.5	6187.5	1031.25	1031.25	2062.5	11000

Machin hours	0	5600		800	0	6400
Pa	0	3675		525	0	4200
Pb		1925		275		2200

Greenwich:
	Receiving	Cutting & Assembly	Heat Treat.	Testing	Pack. & shipping	Total
Labor hours	3000	3000	1000	1000	2000	10000
Pb	75	75	25	25	50	250
Pc	975	975	325	325	650	3250
Pd	1950	1950	650	650	1300	6500

Machine hours		90000		20000	20000	130000
Pb		3462		769	769	5000
Pc		34615		7692	7692	50000
Pd		51923		11538	11538	75000

Schedule 12 Allocation Rates of Overhead costs to Departments/Activities
Jewett City:
Expenses		Receiving	Cutting & Assembly	Heat Treat.	Testing	Pack. & ship.	Plant Sustaining
Power	160000	0.06	0.38	0.13	0.22	0.09	0.13
Repairs	150000	0.1	0.4	0.1	0.3	0.1	0.1
Factory Expenses	75000	0	0	0	0	0	1
Factory Support	400000	0	0	0	0	0	1
Inspection	110000	0	0	0	0	0	1
Chemicals & fuel	450000	0	0	1	0	0	0
Deprec-Equip	200000	0.1	0.25	0.3	0.25	0.05	0.05
Deprec-Bldg	150000	0	0	0	0	0	1
Total Overhead	1695000
Labor Hours	32000	2000	18000	3000	3000	6000
Machine Hours	6400		5600		800

Greenwich:
Expenses		Receiving	Cutting, Machining & Assembly	Heat treat.	Testing	Pack. & ship.	Plant Sustaining.
Power	270000	0.09	0.44	0.06	0.26	0.07	0.07
Repairs	300000	0.1	0.5	0.1	0.2	0.1	0.1
Factory Expenses	125000	0	0	0	0	0	1
Factory Support	350000	0	0	0	0	0	1
Inspection	150000	0	0	0	0	0	1
Chemicals & fuel	1200000	0	0	1	0	0	0
Deprec-Equip	600000	0.06	0.42	0.13	0.33	0.04	0.02
Deprec-Bldg	250000	0	0	0	0	0	1
Total Overhead	3245000
Labor Hours	10000	3000	3000	1000	1000	2000
Machine Hours	130000		90000		20000	20000

Exhibit 1

Description of Departments

Receiving where materials and supplies are ordered, received and forwarded to the plant floor.

Cutting & Assembly (JCP) where skilled workers cut the sheet metal, inspect it for quality and precision, and assemble product Pa. Product Pb is finished in this process.

Cutting, Machining & Molding (GP) where computer numerically controlled (CNC) machines are used to cut, mold and finish products Pc & Pd. Product Pb is sent unfinished to JCP.

Heat Treatment where products are immersed in chemicals at high temperature for hardening.

Testing where 100% of the products are tested for quality and performance.

Packing & Shipping where goods are packed and shipped to customers.

Repairs & Maintenance maintains machines, equipments and buildings.

Exhibit 2

Description of Costs

Direct materials consist of sheet metals and welding material. The quantity for each of the four products is specified.

Direct labor includes wages and benefits. Workers are assigned to processes. Machine set-up time costs are also included.

Power & heat includes the cost of power consumed by the machines as well as for heating and lighting.

Repair & maintenance include costs associated with repairing and maintenance of machines and equipment.

Factory expenses include property taxes, building up keep and sanitary costs.

Factory support includes salaries & wages and benefits of non-direct labor such as plant managers, supervisors, etc.

Inspection costs includes salaries and benefits of quality-inspectors who roam throughout each plant inspecting parts and machines.

Chemicals & fuel includes the costs of chemicals, fuel and labor costs

Depreciation-equipment depreciation costs of machines, tools and other equipment.

Depreciation-buildings depreciation expenses for the two plants. The JCP also house the administrative offices.

Design & engineering costs include salaries & benefits of engineers, and other costs of the Design & Engineering department. The department works on product, and factory machines development

Marketing & sales expenses include salaries & benefits of sales staff, and promotions and other marketing costs.

General and administrative costs include top management, accounting, personnel, and legal counsel.