|Cortland Manufacturing Company
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We constantly seem to be pricing ourselves out of some
markets and not charging enough in others. Our pricing policy is pretty
simple: we mark up our full costs by 50%, so, for example, a computer
that costs us $2,000 to make would sell for $3,000. Until today, I
thought this was a workable approach, but now I’m not so sure.
The speaker was Steve Works, CEO of Cortland Manufacturing, Inc.
(CMI), who had just been told by his accountant that, with revised
overhead allocations, his computers might be priced inappropriately. He
When I was at LBS [Leland Business
School], I focused most of my attention on operations and marketing. I
was convinced that they were the keys to a successful career. Cost
accounting was always a drag, but now I’ve got my accountant telling me
that I need to think about a different way to assign manufacturing
overhead to products, and I don’t even know where to start. I never
dreamed that some day my career would come to this!
CMI manufactured several different models of computers that it
sold directly to hospitals and health systems in all 50 states of the
United States. The company prided itself on the user-friendly nature of
its computers, and in particular on the ability of computers to
facilitate graphical presentations. It was superb graphics that CMI
claimed distinguished its computers from those of its competitors.
Hospitals located the computers at nursing stations, and both nurses
and physicians had found them invaluable to obtaining patient-related
information on a real-time basis.
purchased its raw materials in units that were made to its
specifications. It used a single factory to manufacture all its
computers. The factory workers operated three kinds of machines.
Inspecting machines checked the raw materials and tested the components
to assure that they met the company’s specifications. Soldering
machines then soldered various components together. Assembly machines
put all the components together into finished products (which varied by
About 40 percent of CMI’s
manufacturing overhead was for depreciation, maintenance, and repairs
on the inspecting, soldering, and assembly machines. The rest was in
receiving and handling the raw materials, in adjusting the machine to
set them up for each batch of computers, and in inspecting the finished
computers and packing them for shipment. The actual manufacturing
effort (inspecting, soldering, and assembly) was mainly automated, and
CMI used little direct labor. The company also operated on a
just-in-time (JIT) manufacturing basis, such that there were almost no
inventories at the end of each month.
of the computers sold in large quantities. However, the Cortland 2000
did not. It represented a recent effort by CMI to enter the scientific
computing market by focusing on physicians who managed large research
grants and needed sophisticated computing power in their laboratories
and other research facilities. It was a state-of-the-art computer with
several special features. In particular, it (a) used a new processing
chip that the company imported from Sweden, (b) had special patented
random access memory (RAM) that gave it an extremely high input-output
speeds, and (c) was manufactured in very small batches to assure
uniform quality from one computer to the next.
Determine the full product cost and selling
prices of one Cortland 1000 and one Cortland 2000 under the current
product costing system. How would these costs change under an
activity-based costing system?
2. What are
the reasons for the differences between the two systems? More
generally, what are the characteristics of a computer whose
manufacturing cost will increase under the product costing system being
proposed by the accountant? Please be specific.
3. What should Mr. Works do?