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Holly Manufacturing Case: activity based costing

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:
(see the attached file)

These manufacturing overhead costs are 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.

A. What should Holly Manufacturing do if the quantity of custom cellos sold at the new price falls to 50 per year?
B. What should Holly Manufacturing do about the situation if the price of the custom cello cannot exceed $900?
C. At a selling price of $1,000 each, what is the breakeven unit volume for the custom cello?


Solution Preview


First, I computed the overhead per unit using activity based costing (see Excel for these computations). This spreads the overhead based on the use of overhead resources rather than assuming that all overhead resources are used in the ratio of direct labor hours. That is, rather than giving both product lines half of the overhead, it spreads the overhead based on how much space they use in the building, the labor hours as an indicator of maintenance needs, orders, inspections, and units. Since these are not consumed half by custom and half by standard, the amount of overhead spread and the overhead per unit, differ.

A. What should Holly Manufacturing do if the quantity of custom cellos sold ...

Solution Summary

This tutorial includes 464 words of discussion, an activity based costing analysis of unit costs and a computation of breakeven in units for the custom cello.