VisAudioTech Corporation commenced operations thirty years ago in the competitive entertainment technology industry, producing custom made remote controls for videos. A few years ago, VisAudioTech began manufacturing several different types of remote controls and now two of these, account for the majority of the company’s sales. This case focuses on these two types of remote controls: the simple universal remote control for digital 4K television and 4K DVD player (4TD) and the deluxe universal remote control for surround home theatre and room lighting (SHTL).
The 4TD remote control has been the more common product in the industry for several years. The market for this remote control is quite competitive and price sensitive. VisAudioTech plans to sell 71,500 4TD remote controls in the 2020/2021 year at $150 each. The SHTL remote control is a recent addition to the Company’s product line.
This remote control is different to the 4TD namely, it incorporates technology that is more sophisticated and the materials used in its production are different to those used for 4TD remote control. As such, management has decided to sell SHTL remote control at a premium price. The sales budget for 2020/2021 includes the sale of 44,000 SHTL remote controls at $325 each. In addition, there is no beginning or ending inventory budgeted for the year.
The management team at VisAudioTech usually meet to discuss key issues affecting the company. Since the company’s profitability over the last two years has not met expectations, the decision was made to schedule monthly meetings. Hence, beginning with the current month the next few meetings will focus on discussing strategies to increase the company’s overall profitability in 2020/2021.
In the first meeting, the main topic that management focused on was how to spend the sales and promotion dollars for 2020/2021. During the meeting Faye King, the National Sales Manager, said “I believe the market share for 4TD remote controls could be expanded, by concentrating VisAudioTech’s promotional work in this area”. In response to this suggestion the Production Manager, Peter Togil, shook his head and said, “I disagree. I believe the company should go after a bigger market for the SHTL remote control. The costing sheets that I get show the contribution from the SHTL remote control is approximately four times the contribution from the 4TD remote control. As we get a premium price for the SHTL remote control, focusing on expanding its sales should help overall profitability”.
VisAudioTech currently uses a traditional costing system. Budgeted direct materials costs are $12,826,000 in total, for production of the two types of remote control with $6,534,000 being the total budgeted cost for SHTL direct materials. Direct labor is budgeted at $15.40 per direct labor hour (DLH). The company expects to use 4 DLH and 1.5 machine hours (MH) each SHTL remote control and 1.5 DLH and 0.5 MH for each 4TD remote control produced.
This traditional costing system was developed a number of years ago when the company first commenced operations and uses three types of manufacturing overhead: material-related overhead, variable overhead and machine-related overhead. VisAudioTech applies a materials handling charge at 10 percent of direct materials cost, which is not included in variable factory overhead. Variable manufacturing overhead is applied on the basis of direct labor hours. For 2020/2021 the budgeted variable manufacturing overhead rate is $4.75/DLH. In addition, machine-related overhead is applied on the basis of MH and is budgeted at $20.50/MH.
Vivien Dow VisAudioTech’s Financial Controller, who recently joined the company, had previously worked in another company that used a different costing system which was predominately based on the principles of Activity Based Costing (ABC). Upon having reviewed VisAudioTech’s past financial reports and costing information Vivien became sceptical about the accuracy of the costing data for both the 4TD and SHTL remote controls.
Based on her experience with ABC and the uncertainty she had, Vivien made a suggestion to the management team during the first meeting. She recommended that before the group proceeded with the discussion about allocating sales and promotional dollars to individual products; it may be worthwhile to look at these products on the basis of the activities involved in their production. Vivien further explained, “using this information, we can calculate an activity based cost for each 4TD remote control and each SHTL remote control and then compare it to the traditional cost we have been using”. She also suggested at assessing the activities involved in production. The management team all agreed that Vivien should go ahead with the activity analysis she suggested and present the results.
Subsequently, Vivien and her team conducted an activity analysis and identified that the original three overhead categories used under the traditional costing system involved a series of different activities.
Approximately 30% of material related overhead involved the procurement of material parts; 25% involved the scheduling of production for each of the 4TD and SHTL remote controls; 10% involved moving materials around the production facility and the remaining overhead was incurred for packaging and shipping of the remote controls.
Quality control accounted for half of the variable overhead and involved ensuring that finished remote controls conformed to the design specifications for each type of remote control. The other half of the variable overhead comprised of: setting machines up in preparation for production; disposing of waste; and ordering and maintaining general supplies, which are used in producing the completed remote controls. These were incurred in the ratio of 0.9: 0.09: 0.01 respectively. Production/machine- related overhead, now considered a conversion cost, involved machine soldering of the 4TD and SHTL remote controls and inserting material components into each 4TD and SHTL remote control.
The cost of soldering the remote controls amounted to $151,497.50. Inserting material components into the remote controls was a different process, where some of the material components were inserted by machines, and accounted for 30% of the activity cost pool. Other components involved a more manual insertion process where a number of employees manually inserted individual components into the remote controls.
As a result of this analysis, Vivien concluded that the direct labour category was no longer relevant and she also established that the only cost that would remain the same under both the traditional costing method and the ABC method is the cost of direct materials.
Vivien and her team also identified information specific to the 4TD and SHTL remote controls. Each 4TD remote control required two machine setups whilst each SHTL remote control required fourteen setups. A total of forty one components were used to produce the 4TD and SHTL
remote controls. Of these, eight specific components were used in the production of each 4TD remote control and only one of these components, were inserted manually onto the 4TD remote control by production line employees. The remaining components were used in the production of each SHTL remote control and production line employees inserted 22 of these manually onto the SHTL remote control. Materials were moved two times for each 4TD remote control and eleven times for each SHTL remote control.
Both types of remote controls passed an inspection process where the 4TD remote control was inspected a total of two times and the SHTL remote control was inspected a total of eight times. On average 0.50kg of waste would arise from the production of two remote controls i.e. from one 4TD and one SHTL remote control, where approximately 94% of this came from the production of each SHTL remote control.
As part of the analysis, Vivien and her team also identified a number of activity cost drivers. These are in Figure 1 below.
Figure 1: Identified Activity Cost Drivers
Number of Remote Controls Number of Components Number of Material Moves Number of Setups
Number of Inspections Number of Insertions** Kilograms of Waste.
Based on VisAudioTech’s current traditional costing system, as outlined in the case, calculate the total and unit cost expected for the 4TD and the SHTL remote controls.
Vivien and her team have asked you to help them design a new costing system based on the observations of their activity analysis and on the principles of ABC. As part of this task you are required to:
(i) Describe in detail the elements of this new costing system justifying the activity cost pools and activity cost drivers included. You will need to quantify the normal capacity of each activity cost driver.
(ii) Calculate the total cost and unit cost expected for the 4TD and SHTL remote controls using this new ABC system designed above.