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Holly Manufacturing Case Study

Posted by:Prof. Lexx Posted on:May 30,2016

AC

Holly Manufacturing Company produces two cello models. One is a standard acoustic cello that sells for $600 and is constructed from medium-grade materials. The other model is a custom-made amplified cello with pearl inlays and a body constructed from special woods.

The custom cello sells for $900. Both cellos require 10 hours of direct labor to produce, but the custom cello is manufactured by more experienced workers who are paid at a higher rate.

Most of Holly’s sales come from the standard cello, but sales of the custom model have been growing. Following is the company’s sales, production, and cost information for last year:

Cello   Standard Custom
Sales and production volume in units

 

900 100
Unit Selling Price   $600.00 $900.00
Unit costs:
  Direct materials $150.00 $375.00
  Direct labor $180.00 $240.00
  Manufacturing overhead* $135.00 $135.00
    Total unit costs                                       $465.00 $750.00
Unit Gross Profit   $135.00 $150.00
Direct Labor Hours 10.00 10.00
Direct Labor Rate Per Hour $18.00 $24.00
*  Manufacturing overhead costs:
       Building depreciation $ 40,000
       Maintenance    15,000
       Purchasing    20,000
       Inspection    12,000
       Indirect materials    15,000
       Supervision    30,000
       Supplies    3,000
    Total manufacturing overhead costs $135,000

Selling and Administrative expenses:

Commission to sales person                       3 % of Sales Revenue

Advertising, CEO salary, etc.              $ 30,000  per year.

*         These manufacturing overhead costs are company-wide,  fixed in nature: they do not vary with the volume of manufacturing activity.

The company allocates overhead costs using the traditional method. Its activity base is direct labor hours. The predetermined overhead rate, based on 10,000 direct labor hours, is $13.50 ($135,000 ÷ 10,000 direct labor hours).

Johann Brahms, president of Holly, is concerned that the traditional cost-allocation system the company is using may not be generating accurate information and that the selling price of the custom cello may not be covering its true cost.

President Brahms has hired your consulting team to help him understand cost allocation and provide more accurate information and advice. Here are some questions to guide your work.

  1. The cost-allocation system Holly has been using allocates 90% of overhead costs to the standard cello because 90% of direct labor hours were spent on the standard model.

How much overhead was allocated to each of the two models last year?

Discuss why this might not be an accurate way to assign overhead costs to products.

  1. How would the use of more than one cost pool improve Holly’s cost allocation?
  1. Holly’s controller developed the following data for use in activity-based costing:
     Manufacturing Standard Custom
Overhead Cost Amount       Cost Driver Cello Cello
Building depreciation $40,000       Square footage 3,000 1,000
Maintenance $15,000       Direct labor hours 9,000 1,000
Purchasing $20,000       # of purchase orders 1,500 500
Inspection $12,000       # of inspections 400 600
Indirect materials $15,000       # of units manufactured 900 100
Supervision $30,000       # of inspections 400 600
Supplies $3,000       # of units manufactured 900 100
Total $135,000
  1. Use activity-based costing to allocate the costs of overhead per unit and in total to each model of cello. Show all supporting calculations. It is appropriate to use an excel document to do your computations in Excel
  1. Calculate the cost of a custom cello using activity-based costing.
  1. Why is the cost different from the cost calculated using the traditional allocation method?
  1. At the current selling price, is the company covering its true cost of production? Briefly explain
  1.   What price could Holly Manufacturing set that would give about the same profit margin (% ) as the standard cello?  Show all calculations.
  1.    What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?
  1.    What should Holly Manufacturing do about the situation if market conditions are such that the price of the custom cello cannot exceed $900?
  1. At a selling price of $600 for the standard cello and $1,000 for the custom cello, and assuming the same product mix, what is the breakeven unit volume for each cello (remember it is difficult to sell a fraction of a cello, so round-up. You need to consider the product mix when selling 2 products).

Please show President Brahms a contribution Income Statement reflecting the sales at breakeven.

Write a brief report to President Brahms explaining your conclusions and the benefits of your suggestions.   What are the lessons learned from this case that can help him understand cost allocation.

AC


Prof. Lexx

Overview I have a Bachelor of Arts, majoring in English and minoring in History. I have worked in various fields ranging from academic research to freelance translating to editing to customer support and data entry. These include editing my old university's newspaper as well as co-leading their creative writing team; serving as a junior member in the history department's research network; publishing music and film reviews for several different magazines and webzines; and translating papers and books for numerous researchers in various languages, including Russian, Spanish, and Romanian. I am also a skilled typist, with a rate of at least 70 words per minute, and have myself digitized dozens of books and essays for both private and commercial use. I have a very strong work ethic, and make sure to prioritize the task I am given so that it is completed as quickly as possible. I am organized and disciplined, ensuring a job done professionally and efficiently.

    I have a background of 8 years in writing profession and currently pursuing also as an editor and proofreader. I have a knack for writing and thus, it was obvious to enhance my skills and serve others. Currently joined ‘Member of Association of Professional Writers and Editors’ a

    Pro Alex
    USA