The Crimson Press Curriculum Center

First Page and the Assignment Questions:
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 continued:

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!

BACKGROUND

   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.

    CMI 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 computer model).

   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.

   Most 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.

Assignment

1.       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?